Law and Insurance

Perfect Storm Brewing Over Climate Change Disclosures Sought By Regulators From Insurance Industry

Just before hurricane season heats up, the winds are starting to blow from the insurance industry over questions posed by a committee of the National Association of Insurance Commissioners (NAIC) in a white paper outlining the "Potential Impact of Climate Change on Insurance Regulation."  (See Adopted White Paper).  Unless or until insurance regulation is federalized, the NAIC remains the most powerful body overseeing the U.S. Insurance industry, and for the last year or so has fixed its sights on preparing for climate change.  The Climate Change Task Force of the NAIC has promulgated nine questions to insurers (paraphrased as follows):

1. Do you have a plan to mitigate your own emissions?
2. Do you have a policy for handling climate change risk and investment management?
3. Have you considered the impact of global warming on your own investment portfolio?
4. What steps have you taken to encourage policyholders to reduce losses from climate change?
5. Describe your use of computer modeling to assess global warming impact.
6. Do you know of any trends or effects of global warming that may have a material impact on your operations or financial condition?
7. Are there geographic locations (read Gulf coast) where you are reducing business or line of insurance you are reducing or eliminating due to global warming?
8. What analysis have you conducted on the impact of global warming on your business?
9. Describe steps you have taken to engage key constituencies on the topic of climate change.

The industry's response has been, well, mixed.  Immediate comment by spokespersons for the American Council of Life Insurers and the Property Casualty Insurers Association of America was concern over the potential public release of proprietary and competitively sensitive information.  (See NAIC Climate Change Blueprint for Insurers).

Interestingly, recent comment has focused on the political aspects of the NAIC requests.  Robert Detlefesen, vice president of the National Association of Mutual Insurance Companies, stated that the disclosures are "essentially a call-to-action that seeks to enlist insurers in a campaign to promote an agenda informed not by science or evidence, but by the policy predilections of a handful of interests groups."  (See story posted on ClimateWire).  Mr. Detlefesen may have been reacting to the involvement in the NAIC process of such public and consumer interest groups as Center for Economic Justice and Ceres. 

Other industry voices suggest more openness to some kind of disclosure process and dialog with state regulators.  After all, the insurance industry was probably the first from the private business sector to take global warming seriously and begin planning.  What happens in 2009 from the NAIC disclosure-requests may depend on the 2008 hurricane season.  Another Katrina or Rita and the NAIC may issue subpoenas and promulgate interrogatories; or maybe it won't have to.

Unjustified Severance To Departing Officer Is Uninsurable Disgorement, Says Houston Federal Court

National Union Ins. Co. of Pittsburgh v. U.S. Bank and John Stanley, # 4:07-CV-1958 (S. D. Tex., June 11, 2008)

Because Texas courts rarely have the opportunity to interpret directors and officers (D&O) insurance policies, the U.S. Bank decision is worth a look.  This case concerns D&O coverage, or lack of it, when an insured officer of a failing company was forced to disgorge his $2.27 million severance payment in a bankruptcy proceeding (the company was insolvent at the time), even though the severance had been approved by the board of directors.  The defendant officer sought reimbursement from his D&O insurer.  However, the insurer denied coverage arguing that covered "loss" did not include (1) matters uninsurable under the law, or (2) profit or advantage to which the insured was not legally entitled.  Disgorgement, said the insurer, is both uninsurable and an justified profit.

By the way, the distinction between loss or damage on the one hand and disgorgement or restitution on the other is a hotly contested insurance issue across many jurisdictions and many lines of insurance, not just D&O.  If the insured is simply giving back what it had no right to receive in the first place, then insurance shouldn't provide a windfall to the insured.  But it is not always easy to tell the difference between money damages and disgorgement of money.

In this case, U.S. Bank was in trouble long before the current D&O insurer, National Union, came on the scene.  The bank went through bankruptcy in 1999, and was back in business in 2000 under a reorganization plan that put John Stanley in the driver's seat as CEO for at least three years.  The plan provided for a severance payment of varying amounts depending on whether or not termination was for cause.  The bank continued to fare poorly.  In 2002, the board determined to exercise the termination option.  After tough negotiations (in which Stanley threatened to drag the bank through litigation if he did not get favorable severance terms), Stanley agreed to resign, and the board agreed to characterize his resignation as "termination without cause," allowing Stanley to receive up to $3 million severance.  If he reigned, he got no severance.

Back to bankruptcy court.  The bank was insolvent at the time severance payments were made to Stanley, and the liquidating trustee (curtains for U.S. Bank) sought to recover the payment as an avoidable preference and a fraudulent transfer.  In an adversary action, the bankruptcy court found that Stanley was a bank insider during negotiations of his severance, that he in fact resigned, and thus was entitled to no severance.

Stanley sued National Union for indemnity of the disgorged severance arguing that he incurred a covered loss under the D&O policy.  Stanley argued that he had a clear contractual right to the severance.  He was not giving back that to which he had no right.  Wrong, said the court.  The underlying adversary action determined that he had no contractual right because he resigned voluntarily.  The board action characterizing the resignation as termination for cause was done under threat of litigation and thus was a sham transaction. 

Accordingly, said the court, the payment was both an uninsurable disgorgement and a profit or advantage to which Stanley had no legal right.  Summary judgment for National Union granted.  Case dismissed.

In view of the lower court's determination that Stanley had no contractual right to the severance, this is an easy case for the district court.  However, as mentioned above, it is not always so easy to distinguish loss from disgorgement.  In many transactions, after money has changed hands or securities have been bought and sold, what seems to be loss or damage to the allegedly injured plaintiff can also be called unjust enrichment to the defendant.  So, is the plaintiff recovering damages, or is the defendant disgorging ill gotten gain?  Policyholders should be aware that insurers press the later position frequently and vigorously.

Parties Under Contractual Indemnity Obligation May Seek Equitable Subrogation -- So What's New?

Frymire Engineering Co. By and through Real Part In Interest, Liberty Mutual Ins. Co. v. Jomar Int'l, Ltd., #06-0755 (Tex. June 13, 2008), see Frymire Decision.

I am not sure why this case was ever a problem.  It looks like a run-of-the-mill insurance subrogation case, but for some reason both the lower courts and the Texas Supreme Court approached the subrogation issue as if Liberty Mutual wasn't involved.  So, the lower courts got hung up on the issue of whether a manufacturer of a defective product owes a "debt" to the injured plaintiff and whether payment under a contractual indemnity agreement is "voluntary."  The result is a helpful clarification that a contractual indemnitor, here Frymire, that pays a loss does not lose its equitable subrogation rights against a third-party tortfeasor.

For those lucky enough not to have grappled with subrogation issues before, subrogation is the right to collect a payment for a loss made on behalf of the person primarily responsible for causing the loss.  Typically, insurance companies that pay to or on behalf of insureds seek subrogation from some third party primarily responsible for the loss or liability.  The insurance company has a contractual right under its policy to seek subrogation.  However, in this case, the court considered Frymire's equitable subrogation right, meaning one not based on contract or statute, but based on inherent principles of fairness.

Frymire contracted with a general contractor to install air conditioning at a hotel.  Frymire installed a valve manufactured by Jomar. The valve leaked causing extensive damage.  Frymire had agreed both to indemnify the general contractor and hotel owner and to purchase liability insurance (Liberty Mutual).  Accordingly, the hotel sued Frymire for contractual indemnity.  (Note that the hotel could have sued in tort or breach of contract rather than contractual indemnity, which appears to be the sticking point for the lower court.)  Liberty Mutual paid $458,496 on behalf of Frymire.  Liberty Mutual next brought a subrogation suit to recover its payment from Jomar alleging that the valve was defective.  As the Court observed (see below), this kind of subrogation suit happens all the time.

But Jomar argued that Liberty Mutual had no standing to bring its subrogation suit because Frymire had no standing to sue Jomar.  The Court demolished Jomar's argument with a solid reaffirmation of the doctrine of equitable subrogation, to wit: one not acting voluntarily that has paid a debt that another party should have paid, may recover from the other to prevent the other's unjust enrichment.  Jomar obtained summary judgment, affirmed on appeal, that Frymire lacked standing to assert its claims because it could not establish a right to equitable subrogation.  Specifically, because Frymire paid the hotel to satisfy its own contractual indemnity obligation, the payment was voluntary and did not unjustly enrich Jomar.

The Texas Supreme Court reversed this holding and accepted Frymire's argument that (1) the indemnity payment extinguished the debt primarily owed by Jomar; (2) the indemnity payment was involuntary because it was made under a contractual obligation; and (3) Jomar would be unjustly enriched if it escaped liability for its defective product.  The Court confirmed that tort liability could be considered a "debt" for purposes of applying equitable subrogation.  Moreover, one paying under a contractual obligation is not a volunteer and may seek subrogation.  The Court noted that insurance companies have contractual obligations to pay losses to or on behalf of insureds and seek subrogation all the time.

Which raises my original question: why isn't this case being treated as one in which the insurance company is asserting its routine right to subrogation?  Liberty Mutual paid the claim to the hotel.  Liberty Mutual is the party seeking payment from Jomar. 

Whatever the answer, this case should strengthen the rights of commercial entities of all kinds that step up to the plate and promptly pay claims to resolve business disputes and then seek to recover from the party that should have paid the claim.

Court's Refusal To Analyze Plain Meaning of "Hostile-Fire" Exception In Pollution Exclusion Burns Insured

Noble Energy, Inc. v. Bituminous Casualty Co., #07-20354 (5th Cir. June 2, 2008) see Noble Energy Decision.

In interpreting insurance policies, courts are supposed to give effect to the plain meaning of the contract language without inquiring into broader considerations of the design or purpose of the provision.  In this case, the court whip-sawed the insured by first refusing to consider the insured's "reasonable expectations" of the scope of an absolute pollution exclusion (because courts just give effect to the language as written), but then artificially limiting  the "hostile-fire" exception by what it was designed to cover, not what it actually said.

Noble Energy was an additional insured under the policy of a contractor hired to dispose of "Basic Sediment & Water" (let's call it gunk) from Noble's storage tanks.  The contractor trucked the gunk to waste facilities, where one day a truck caught fire and exploded when fumes from the gunk seeped into the idling engine.  Death and destruction resulted, and ensuing litigation eventually narrowed to the insurer's refusal to cover Noble's damages due to the absolute pollution exclusion in the policy. 

Pollution exclusions currently enjoy very broad application under Texas law eliminating coverage for all sorts of non-pollution accidents such as tipsy falls from scaffolding due to paint fumes and carbon monoxide deaths caused by careless roofers that covered the chimney with their tool box.  Noble argued that the pollution exclusion was not intended to exclude this type of mishap, but the court, following the Texas Supreme Court's lead, stuck to the plain meaning of the policy.  The fumes from the gunk were a "pollutant," out of which arose the event.

But the pollution exclusion had a hostile-fire exception which states:

[The pollution exclusion clause] does not apply to bodily injury or property damage caused by heat, smoke or fumes from a hostile fire.  As used in the exclusion, a hostile fire means one which becomes uncontrollable, or breaks out from where it was intended to be.

Noble argued that the deaths and injuries were caused by the heat of a hostile fire.  Rather than consider this argument (I can certainly see a counter argument that "heat" and "fire" are not the same thing, and the deaths were cause by explosion, not heat -- but that wasn't raised).  Instead, the court looked to a California federal court decision to infer that the hostile-fire exception applies only if a pre-existing fire causes the pollution.  [Emphasis in original]

But that is not what the policy says.  The court's interpretation is a reasonable inference from the language, but so is Noble's.  I admit, I find the insurer's interpretation more reasonable than Noble's.  But the rules of policy interpretation require a court to give effect to the insured's reasonable interpretation of an exclusion, even if the insurer's interpretation is more reasonable. 

The court should have analyzed Noble's interpretation to determine if it could fit the plain meaning of the exception.  If so, the exception should have applied. Instead, the court jumped to a conclusion, relying on a non-controlling case, that hostile-fire exceptions only apply when the fire causes the pollution.  That is probably what the drafters (insurers) had in mind, but they didn't necessarily draft it that narrowly. 

"Systemic Problems" At Group-Home Facility Held To Prohibit Coverage For Punitive Damages

American Int'l Specialty Lines Ins. Co. v. Res-Care Inc., No. 04-20389 (5th Cir. June 2, 2008) see Res-Care Decision.

In February 2008, the Texas Supreme Court held that punitive damages could be insurable under certain narrow circumstances.  See my discussion of Fairfield Ins. Co. v. Stephens Martin Paving, LP, 246 S.W.3d 653 (Tex. 2008) at Supreme Court Finds No Broad Prohibition of Insurance Covering Punitive Damages - But.  Fairfield found that punitive damages against a grossly negligent employer could be covered under a workers compensation policy because the legislative purpose for allowing those punitive damages was in part to compensate the family of the deceased worker (Texas' workers' compensation law permits a lawsuit against the employer only for wrongful death caused by the employer's gross negligence).  The Court held that public policy did not bar insuring punitive damages when (1) the Legislature expressly allowed such recovery, (2) the purpose was to compensate the plaintiff or deter others, or (3) the insured is a corporation punished for the gross negligence of its employee "[w]here other employees and management are not involved in or aware of an employee's wrongful act."

The Res-Care court addresses the last of the three situations in which punitive damages may be insured.  To appreciate the court's decision to bar insurance from the corporate defendant, we must review the parade of horribles that befell a 37 year old resident at a group-home that provided services for the mentally disabled.  After the resident fell in a hallway and defecated on the floor, an employee poured undiluted bleach on the floor and escorted the other residents outside, leaving the fallen resident in her own feces and bleach for at least an hour before dragging her into a bathroom.  Even then, the resident was not cleaned.  Two other staff members found the resident in the bathroom and put her in clean clothes, treated her with Vaseline, and put her to bed without washing off the bleach.  The resident was not taken to the facility's doctor until 17 hours after the incident.  The doctor diagnosed her with only superficial burns and prescribed pain medication and whirlpool treatments, which were further delayed.  Later, a facility nurse noted the burns but did not follow up until the next day when the resident's skin began peeling off.  She was finally taken to the hospital where she died from complications due to severe burns that covered 40% of her body.

The ensuing lawsuit settled for $9 million, $5 million of which was allocated as punitive damages in a subsequent trial. (Very interesting discussion of the lower court's "Enserch" trial, named after Enserch Corp. v. Shand Morahan & Co., 952 F.2d 1485 (5th Cir. 1992) holding that the allocation between covered and uncovered portions of a settlement must be determined by factfinders in an actual trial -- but that is another issue).  The Res-Care Court affirmed the lower court's finding that Res-Care could not tap insurance to pay for the punitives, not only because several employees appeared grossly indifferent to the resident's shockingly obvious distress, but -- here's the killer -- several prior reports from the state described a level of failure of care that "evidenced systemic problems at the facility."

This case presents a closer call on Fairfield's corporate exception to the public policy bar than might appear on a first reading.  The Res-Care Court could have allowed coverage because management was not aware of the specific treatment in this case.  Remember, coverage should not be denied based on how egregious the employee's conduct was or how badly we may want to deter such neglect.  The sole consideration should be whether the corporation should be punished for the wrongful conduct of its employees.  Had the lower court gone the other way, the appellate court would probably have been justified in affirming that decision as well. 

However, we now have a "systemic problem" prohibition against allowing a corporation to insure against the gross negligence of it employees.  Texas thereby takes a step closer to California's total ban on insuring punitive damages.

How Does The Eastern District of Texas Federal Court Handle A Fraudulent Insurance Claim? Like Any Other Competent Court - By The Law

Jong Mao v. State Farm Lloyds, Inc., #6:07-CV-310 (E.D. Tex. May 20, 2008).

I don't usually comment on personal lines insurance matters, but this attempt to scam a homeowners insurer caught my attention.  The scheme was as brazen as the court's treatment of it was, well, understated.  Boiled down to essentials, the insured purported to rent a house to herself and collect lost rentals paid to herself after a fire.  However, like most fraudulent schemes, this one requires our attention to a shell game of sorts, or at least an attempt at one.

An individual, Jong Ock Mao, aka Jong O. Mao, aka Jong Ock Hahn, or her trust, the "Jong Ock Mao Declaration of Trust Dated July 17, 2001," is the sole shareholder of two corporations: Jong's Consulting, Inc. and MX Oasis, Inc.  In 2005, Jong's Consulting, Inc. purchased a house in Palestine, Texas, and Ms. Mao purchased, in her own name (one of them anyway) a homeowners policy from State Farm Lloyds.  In December 2005, Jong's Consulting leased the property to MX Oasis for a monthly rental fee of $6,000.  Ms. Mao executed the lease (1) as lessor with name, "Jong Ock Mao," and (2) as lessee with the name, "Jong O. Mao."  Fire destroyed the structure and contents on September 25, 2006.

In a footnote, the Court noted that a notice of lis pendens against the property had been filed on August 26, 2006 as a result of a felony indictment against Jong in connection with a California forfeiture action.  But neither State Farm nor the Court paid much attention to that.

At any rate, State Farm was notified and raised a few questions about the part of the insurance claim for lost rent (the policy covered loss of rental value) because Mao appeared to have rented the property from herself.  In a series of letters from her attorneys (she had a least two of them), Ms. Mao explained the various ownership interests of the companies, confirming on the one hand that she was the "sole owner" of both Jong Consulting and MX Oasis, yet also relating that all her interests had been transfered to the Trust in 2001.  No doubt thoroughly confused, State Farm wrote back and rejected the lost rental claim either because Ms. Mao, the sole policyholder, was a separate legal entity from the corporations, which accordingly had no right to policy proceeds, or the companies were her "alter egos," and she was making dummy rental payments to herself.  So she sued.

The court opted for State Farm's first theory and explained that a shareholder is a distinct legal entity from the corporation.  Because only Jong Consulting had the right to receive rental proceeds, and because the policy covered Mao only in her personal capacity, neither Mao nor Jong Consulting was entitled to policy proceeds. 

Reading between the lines, Mao appears to have outsmarted herself.  The court noted in a footnote that it made no difference whether Mao or the Trust was the sole shareholder of the two corporations.  Yet it appears that Mao hoped to get away with her sleight of hand transaction by pretending that a trust is in a sort of no mans land between corporations and individuals.  In other words, she hoped (I think) that her Trust could masquerade as both policyholder and lessor yet avoid the appearance of the same person paying rent to herself.  However, the Court did not waste breath over the existence of the Trust.  It would not have mattered anyway.  In a shell game, it doesn't matter if the shell is a corporation or a trust - they are both fictions.

The Court is to be commended for handling this case quietly and succinctly, no doubt leaving responsibility for more serious action to the State of California and the extradition process.

Pollution Exclusion in D&O Insurance Policy Should Not Completely Bar Shareholder Securities Claim, Says Canadian Court

Boliden Ltd. vs Liberty Mutual Ins. Co., 85 O.R. (3d) 492 (Ontario Superior Court of Justice, April 1, 2008) see Boliden Decision

Several years ago, a federal appeals court sent shivers through many American boardrooms by ruling that a securities lawsuit, brought derivatively by shareholders over alleged misrepresentations in SEC filings, was not covered due to a pollution exclusion in a Directors & Officers (D&O) insurance policy.  It seems that the alleged misrepresentations concerned management's failure to report certain fines and costs for a subsidiary's mishandling of waste (the company was in the waste-hauling business), and the exclusion applied to any claims "arising out of pollution [including waste])."  See National Union Fire Ins.Co. v. U.S. Liquids, Inc., 88 Fed. Appx. 725 (5th Cir. 2004).

U.S. Liquids never expected its D&O insurer to cover pollution lawsuits or clean up costs, but it was shocked to learn that it had no coverage for shareholder securities actions simply because the remote subject of alleged SEC misstatements related to operations that related to pollutants.  Foul!

In a case of first impression in Canada, the Boliden court reached the opposite conclusion, at least in part.  The facts are substantially similar to those in U.S. Liquids.  A Spanish subsidiary owned a mine which flooded large tracts of land with contaminated tailings after a dam failed.  Boliden's shares plummeted, and shareholders sued the company alleging misrepresentations in a Prospectus issued a year before the disaster in an initial public offering.  The D&O insurer refused to cover the claims relying on the pollution exclusion ("[Insurer] shall not be liable under this policy to make any payment for loss respecting a claim . . . for or in respect of pollution loss.")

Boliden argued that the loss in question was the drop in value of its shares, not the damage to land and rivers in Spain.  Insurer said the loss in value of shares was caused by the discharge of pollutants and so fell within the exclusion.  Liberty also pointed to U.S. Liquids and other American cases.  However, the Canadian court noted that the American cases applied very broad "but for" causation, which Canadian courts do not accept.

Finding little helpful guidance from Canadian cases discussing causal language (such as "arising out of," "attributable to," and resulting from"), the Court made its own analysis and determined that some of the allegations did not sufficiently involve pollution, though some did.  For reasons not fully explained, the court held that allegations regarding construction defects and poor maintenance of the dam were not excluded, but other allegations were excluded.  The policy contained an allocation clause requiring Liberty to pay 80% of the defense costs where claims involved both covered and uncovered claims.  Accordingly, the court required Liberty to cover 80% of the loss.

Although the result is a victory for the policyholder, the holding may offer little useful guidance if the issue arises again in Canadian jurisprudence.  The court's analysis is very fact-specific.  The best advice to policyholders is to get enhancements to the pollution exclusion before experiencing a loss.  Most D&O insurers are willing to carve out from the exclusion shareholder derivative actions or claims against individual insureds.  The D&O market is still soft, and underwriters are generally in an accommodating frame of mind.  The best way to fix questionable policy language is before a claim is asserted.

"Assumption of Liability" Exclusion Misapplied In Coverage Lawsuit

Underwriters at Lloyd's of London v. Gilbert Texas Constr., 245 S.W.3d 29 (Tex. App.-- Dallas 2007, pet. filed May 7, 2008)

This decision appears to jump the tracks when analyzing the effect of a common CGL policy exclusion for "liability assumed in a contract."  Everyone in the case, Lloyd's, the court, even the insured, appear to agree that the exclusion applies in this case (the insured tries to rely on exceptions to the exclusion), but I think they all misunderstand what it is that is excluded.  So it is worth a look.

Gilbert contracted with the Dallas Area Rapid Transit Authority, a state agency, to help construct a commuter rail system.  Gilbert allegedly breached some of its duties under the contract prompting an adjacent landowner to sue DART and Gilbert.  Gilbert's primary insurer defended it, and Gilbert was able to get all of the tort allegations case dismissed under governmental immunity, leaving only breach of contract claims (apparently, the plaintiff landowner asserted that it was a third-party beneficiary under the DART contract).  Gilbert then settled the breach of contract claims.

It is unclear at this point what happened to Gilbert's primary insurer, but Gilbert's excess insurer, Lloyd's, denied a demand to pay the settlement based on the "assumed liability exclusion" (Lloyd's denial letter also asserted a separate breach of contract exclusion, but that defense is never mentioned in the decision).  Most CGL policies contain this provision that excludes damages which the insured is obligated to pay "by reason of the assumption of liability in a contract or agreement."  Since Gilbert was sued for failing to perform duties it had assumed in the contract, the parties agreed that this exclusion applied and went on to other issues.  But they all appear to misread the exclusion.

It is not an "assumption of duties" exclusion; it excludes "liabilities" assumed by contract.  When I agree to dig a ditch and protect nearby structures in doing so, I undertake contract duties.  If I breach those duties, I may be liable to the parties or beneficiaries of the contract, but that is not what the "assumption of liability" exclusion is about.  To assume liability means that I agree to indemnify and hold someone harmless from legal liability to third parties.  The Gilbert Court converts the "assumption of liability" exclusion into a "breach of contract" exclusion, which is a different animal.

It is now clear that a breach of contract lawsuit may be covered by a CGL policy.  (Lamar Homes, Inc. v. Mid-Continent Cas. Co., 239 S.W.3d 236 (Tex. 2007), discussed at Lamar Homes Decision).  Therefore, the mere fact that all tort claims against Gilbert were dismissed does not mean the contract claims do not fall with coverage, and nothing is said about Gilbert's agreements to assume the liability of anyone else.

This case does not implicate the "assumption of liability" exclusion.

Federal Court Reaffirms That Co-Insurers Have No Right of Contribution Under "Other Insurance" Clause

Trinity Universal Ins. Co., Utica National Ins. and National American Ins. Co. v. Employers Mutual Cas. Co., #H-07-0878 (S.D. Tex. May 15, 2008)

This result looks bad for the insurance company plaintiffs, but the real losers in the long run will be policyholders.  Here, the Houston Federal District Court dutifully followed the Texas Supreme Court's holding in Mid-Continent Ins. Co. v. Liberty Mutual Ins. Co., 236 S.W.3d 765 (Tex. 2007) (see my discussion at Mid-Continent Decision) that a co-insurer that wrongfully refuses to contribute its lawful share of a settlement paid by other defending co-insurers owes no duty to pay any reimbursement to those insurers despite its agreement to do so under the "other insurance" clause in its policy.  In effect, the "other insurance" clause is rendered at best meaningless, at worst a positive hindrance to the defending insurer's right to seek contribution from the non-paying insurer.  Why?

Most general liability policies contain some form of "other insurance" or "pro rata" clause to apportion responsibility for payment of defense costs and indemnity when other valid and collectible insurance is available to cover the insured's liability.  This happens frequently, as in the Trinity Universal case.  The insured, Lucy Masonry, was hired to install all the masonry work and facade items for construction of a hospital.  Unfortunately for all concerned, the design called for one of those disastrous synthetic "exterior insulation and finish systems" (EIFS) that seem to be responsible for about half of all construction lawsuits in the last five years.  The system failed, Lucy M. was sued, and about four insurers were summoned to defend and indemnify it in the litigation.  All but one insurer agreed to defend.  Employers Mutual's policy, however, contains an EIFS exclusion, and it denied coverage.  All the policies contained substantially similar "other insurance" clauses, so the three defending carriers brought a declaratory judgment action against EM while the underlying lawsuit was pending.

Because the lawsuit alleged faulty workmanship both inside the building and in the facade, the Court held that EM had a duty to defend, which EM had breached.  But that didn't matter.  Because all the policies contained "other insurance" clauses, the defending insurers lost their common law right of contribution from co-insurers, and their contractual rights were "several and independent of each other, not joint."  What does that mean?  The insurers cannot enforce contractual rights against other insurers with whom they have no contractual relationship.  Lucy M. can enforce contractual rights against EM, but the insured has no damages to assert against EM because Trinity et al. is paying the defense costs.

Moreover, the paying insurers have no subrogation rights against EM because, by definition, subrogation means stepping into the insured's shoes and asserting whatever rights the insured had to recover loss from third parties, like EM.  But at no time did Lucy M. have any loss, since the other insurers covered the defense from the beginning.  Also, the Trinity Court reiterated that a defending insurer owes a complete defense and may not pay the insured only its pro rata share.  Trinity and the others are just suck with the bill.

Unless fixed by the Legislature, this trap will result in fewer insurer offers to defend under reservation.  In the future we can expect co-insurers to refuse to contribute defense costs unless all the other co-insurers also agree to pay.  If one insurer refuses, the others cannot start paying on pain of losing any ability to later get contribution.  It is anybody's guess whether an insurer that reserves it right to refuse to defend pending adjudication of a co-insurer's coverage defenses will be subject to a bad faith claim by the insured.  The Texas Supreme Court has long held that an insurer may agree to defend subject to a reservation of rights to challenge coverage.  Of course, the insurer must then go ahead and defend.  Here, the insurer will try reserve its right to withhold defense payment until it can bring the non-payer to the table.

Whatever the outcome, co-insurers will likely be less willing to offer a defense than before.  Bad news for policyholders.

New York High Court Dodges Critical Analysis of Causal Connection With Additional Insured's Work

Worth Construction Co. v. Admiral Ins. Co., # 52 (N.Y. May 1, 2008) See Worth Constr. Decision

Another additional-insured puzzler, this time resolved by the New York High Court.  The issue: Does a liability insurer have to cover an additional insured general contractor for workplace injuries occurring on the named insured subcontractor's work site but not caused by the named insured's negligence?  Most of the time, both in New York and in Texas, the answer is yes (see my discussion of the Texas Supreme Court ruling in Evanston v. Atofina Decision that only a broad, loose causal connection is required between the named insured's conduct/operations and the injury; on New York law, see Impulse Enterprises/F&V Mech Plumbing and Heating v. St. Paul Fire & Marine Ins. Co., 282 A.D.2d 266 (N.Y Sup. 2001: "The focus of [an additional-insured endorsement] such as St. Paul invokes is not on the precise cause of the accident but the general nature of the operation in the course of which the injury was sustained").  Here, however, the New York Court reached the opposite result based on the peculiar facts of the case.  I think a Texas court would disagree.

Worth, the general contractor on a building project hired Pacific to construct a staircase, which required two separate operations.  Pacific first installed the stairs.  Other subcontractors then poured concrete to form walls around the stairs, after which Pacific was to return to the site to install the handrails.  After Pacific had built the staircase, but before the walls were completed, an iron working subcontractor slipped and fell on fireproofing that had been applied to the stairs by yet another subcontractor.  Pacific was not working on the site at the time and had nothing to do with the application of the fireproofing.  The injured worker sued Worth (but not Pacific) alleging, among other things that the staircase was negligently constructed (this, for me is the crucial fact).  Pacific had agreed to add Worth as an additional insured to Pacific's liability policy, so Worth submitted the claim for defense and indemnity to Pacific's insurer, Admiral.

Admiral denied the claim arguing that the injury did not arise out of Pacific's work.  Worth sued Admiral and asserted that, because the injury occurred on the staircase that Pacific constructed, the claim fell within the scope of the additional-insured endorsement.  After all, said Worth, New York law says look only at the general scope of the operations, not the negligence of Pacific, the named insured (see above). The lower courts agreed, but the Court of Appeals reversed.

One of the peculiarities of this case, which decisively influenced the High Court, was that Worth admitted in the underlying lawsuit that Pacific was not negligent.  Given this admission and the fact that Pacific was not even on the site at the time, the Court determined that the connection between the accident and Pacific's work was too remote.  Here is the critical holding:

Once Worth admitted that its claims of negligence against Pacific were without factual merit, it conceded that the staircase was merely the situs of the accident.  Therefore, it could no longer be argued that there was any connection between [the] accident and the risk for which coverage was intended. [Emphasis added].

But isn't the location of an accident typically the determining factor in applying addition-insured provisions?  What distinction does the Worth Court make when it says Worth conceded that the staircase was merely the "situs" of the accident.  Why use the Latin word instead of the English, "site"?  Beware of lawyers (and judges) when they revert to Latin; they may be trying to finesse or obfuscate a difficult point.  Here I cannot say that the Court exactly nailed the point by saying that the accident only happened on the stairs, therefore "it could no longer be argued that there was any connection between the accident and the risk for which coverage was intended."  Why can't it be argued?  Listen to it:  "Worth should be covered because the accident occurred when the guy slipped on the stairs that Pacific built, and -- by the way -- the guy said in his lawsuit that he slipped because the stairs were negligently constructed." 

Rather than revert to latinisms and circumlocutions (is that Latin?), the Court should spell out its reasoning to allow the parties to recognize what makes an accident too remote from the named insured's conduct to trigger coverage.  Admittedly, this is a close case.  We are left to wonder, for example, why Worth didn't go after the policy of the subcontractor that applied the fireproofing.  How long had Pacific been off the job?  Is fireproofing fundamentally separate from the stairway itself?  It would have been a service to us all if the Court had spelled it out and said what aspect of Pacific's operations was dispositive.

If the case were presented under Texas law, the allegation in the underlying complaint should have removed any objection to coverage.  Texas follows a strict application of the 8-corners rule, and the plaintiff's allegation that he slipped because the stairway was negligently constructed should preclude a court from considering any other evidence, including Worth's admission of non-negligence.  That plus the situs of the accident should be enough under the Atofina Court's decision (see above) to make this an easier case under Texas law.