Law and Insurance

New Marsh Think Tank Sees Large Companies Unprepared for Future Water Shortages

The recently formed Marsh Center for Risk Insights surveyed over 100 corporate-level executives on their views of eight potential crises and found the following percentages of companies that have prepared for them: (see Marsh research)

• 58%   Natural disaster
• 55%   Steep rise in oil prices
• 44%   International terrorist attacks
• 41%   A pandemic disease
• 25%   Global climate change
• 24%   Housing market collapse
• 17%   Reduced access to water
• 12%   Nanotech related risks

Even though roughly half of the executives report that access to water is critical to their companies' businesses, less than 20% of the companies have taken action to prepare for possible water shortages that could result from global warming.  Also surprising is that that 44% of those surveyed said their companies had not prepared because these crises were not seen as relevant to their business.

Research of this kind is useful as we move into the risky 21st century.

Loss Payee Loses Fire Coverage When Designation in Policy Was "To Follow"

Scottsdale Insurance Co. v. Mason Park Partners LP, #07-20102 (5th Cir. September 14, 2007, per curiam)

The owner of commercial property required the lessee of a restaurant to procure insurance against fire and liability and add the owner as loss payee on the fire insurance policy.  The purpose of the ubiquitous loss payee arrangement is to ensure that, in any dispute over the insurance proceeds from the fire insurance, the owner/lessor receives payment first up to the amount of its interest.  Lenders and landlords the world over rely on this device to preserve their priority right to insurance proceeds.  But the device only works if the policy is properly endorsed to reflect the identity of the loss payee.

In this case, after the insured restaurant burned down, the insurer refused to recognize the lessor's rights to the proceeds because the loss payee endorsement bore only the cryptic directive: "to follow."  The endorsement was subsequently canceled, but the insurer was not bound, as would normally be the case, to notify the loss payee of cancellation because no name or address was provided for this purpose.  Therefore, the court had no alternative but dismiss the landlord's action against the insurer.  The case doesn't say what action, if any, the landlord may have against the tenant for failing to see to it that the policy was properly endorsed.  It appears to be one of those little details that so frequently get lost in the shuffle.

The lesson for risk managers is that courts will rarely look beyond the terms of the policy to ascertain the true arrangements between the contracting parties.  Doubtless, the landlord could easily prove its status as property owner and security holder through numerous documents.  But none of this evidence is usually admissible to determine the legal effect of the insurance contract.  The loss payee must protect its rights by insisting on proof that the policy was endorsed.  The best proof is a certified copy of the policy.  At least, the loss payee should insist on receiving a copy of the loss payee endorsement.  Short of this, the landlord is at risk of having nothing at the end of the day but the smoldering ruins of its leasehold.

California Court Says Settlements Are not "Damages" Without An Adjudication

Aerojet-General Corp. v. Commercial Union Ins. Co., #CO51124 (Cal. App., Sept. 13, 2007)

This case should serve as a warning to policyholders to read their policies closely (and with their legal hats on).  "Damages" was held to mean "legally obligated to pay or by final judgment be adjudged to pay," and would not include settlements reached out of court, even if the court approved the settlements.  Thus, the policyholder lost its right to recover $175 million, otherwise covered, because it settled rather than submit to actual trial.

Aerojet sought indemnification from several of its excess liability insurers for the cost of remediating groundwater contamination as a result of a number of lawsuits filed in 2000 and 2001.  If the insurers asserted coverage defenses over the merits of the claims, the case doesn't mention them.  It appears that the excess policies were in effect before 1970 and thus, before pollution exclusions.  Aerojet kept the excess carriers informed of the settlement talks but apparently did not obtain their consent to settlements reached with the claimants.

The California Supreme Court has already held in Certain Underwriters at Lloyd's of London v. Superior Court, 16 P.3d 94 (Cal. 2001) [Powerine I] that the term "damages" operated to limit the insurer's obligation to indemnify only to money ordered by a court and would not include environmental cleanup costs required by an administrative agency.  The California Supreme Court in a later opinion in the Powerine case [Powerine II], found that policy language requiring the insurer to indemnify "expenses" as part of the definition of "ultimate net loss" was enough to require an excess insurer to pay.

Unfortunately for Aerojet, its polices did not include the "ultimate net loss" definition or define "damages" in any way that would expand Powerine I's narrow interpretation.  Therefore, the excess insurers were not required to indemnify the (otherwise covered) settlement payments.

While Aerojet's policies were written more than 50 years ago and so contained standard language no longer in use, the lesson to be learned is still valid.  Policyholders should read their policies and have coverage counsel review the language in light of current legal trends.

White House Threatens To Veto Extension of Terorrism Insurance

According to a story by the Associated Press on Monday, Bush advisers threaten to veto the 15 year extension of the  2001 Terrorism Risk Insurance Act that is working its way through Congress.  See Veto Threat.  The current proposal to extend the government-backed insurance program with added protection for domestic as well as foreign terrorist acts, faces perhaps it strongest opposition so far.  The administration indicates that government should get out of the insurance business.  Proponents argue that without the back-stop insurance program, it will be impossible to obtain insurance, particularly for nuclear, biological, chemical and radiological attacks.

Developer’s Failure To Grant An Easement Did Not Constitute “Loss of Use of Tangible Property” Or “Wrongful Eviction” under CGL Insurance Policy

In this case, a Texas appellate court narrowed the scope of two provisions of the standard commercial general liability policy.  Coverage A of most CGL forms covers “property damage” (“physical injury to tangible property”) but includes “loss of use of tangible property,” even if the property is not injured.  Coverage B covers a number of enumerated “personal injury” offenses, including “[t]he wrongful eviction from, wrongful entry into, or invasion of the right of private occupancy of a room, dwelling or premises that a person occupies by or on behalf of its owner, landlord, or lessor." 

 

Over the years, policyholders have tested the coverage boundaries of these two provisions.  In this case, a residential developer sued its CGL insurer for refusing to indemnify and defend it against a homebuyers’ lawsuit over alleged failure to grant an easement to use certain lakeside property as a park. The developer argued that the homeowners’ alleged loss of an easement constituted a loss of the use of tangible property, or alternatively, an “invasion of the right of private occupancy of…premises.”  The insurer and the court disagreed.

 

The court accepted the insurer’s argument that, although an easement might constitute “tangible property” under the policy, the landowners alleged only that the developer failed to grant them a promised right, and did not allege a loss of the property’s use.  The court reasoned that causing the absence of such an interest was not tantamount to causing a loss of the property’s use because the homeowners never had more than an intangible interest in the property.

The court also refused to accept the developer’s second argument that the alleged failure to grant an easement was an “invasion of the right of private occupancy of…premises.”  The court conducted a cursory review applicable cases, Texas and beyond, and followed the rulings in the 9^th and 10^th Circuits in concluding that the property interests ordinarily protected under personal injury coverage, such as a protection from wrongful eviction or wrongful entry, are clearly distinguishable from nonpossessory interests, such as the homeowners’ easement.

Robert Trotter Gift Fund for Thomas v. Trinity Universal Insurance Co., No. 03-05-00330-CV (Tex. App.-Austin, September 13, 2007)

Insurance Adjusters Face Personal Liability For Statutory Bad Faith In Texas

Insurance adjusters may find themselves as defendants in more insurance bad faith litigation after the Fifth Circuit Court of Appeals decision in Gasch v. Hartford Acc. & Indem. Co., 491 F.3d 278 (5th Cir. 2007), which held that federal courts had no diversity jurisdiction over an insurance bad faith action against an out-of-state insurer and an in-state adjuster because the adjuster was "a person in the business of insurance" and so could be liable under Texas Insurance Code art. 21.21 (now Sec. 541).  Federal diversity jurisdiction is destroyed when one defendant is a citizen of the same state as the plaintiff.  Therefore, although the lower court had dismissed the bad faith claims against both defendants as groundless, which the Fifth Circuit doesn't contest, the case was remanded to the lower court so it could dismiss the action, after which it would continue in state court.  This is not good news for adjusters.

In 1994, the Texas Supreme Court appeared to exonerate adjusters from bad-faith liability in Natividad v. Alexsis, Inc., 875 S.W.2d 695 (Tex. 1994), holding that adjusters under contract with insurers could not be held liable for common law bad faith because they were not parties to the contract between he insured and insurer.  However, since that time policyholders have gained more success pursuing both insurers and adjusters for mishandling claims under Texas' consumer protection statute in Art. 21.21 of the Insurance Code.  Under the statute, a party need not be in contractual privity with the insured to be liable.  It is enough if the party is engaged in "the business of insurance," which the Insurance Code explicitly defines to include investigating or adjusting claims (Sec. 101.501).

The Gasch court refused to apply the reasoning the the Natividad case and found that an adjuster can be liable for unfair claims settlement practices under Art. 21.21.  Because plaintiffs usually prefer to bring insurance lawsuits in state court, we can expect more lawsuits joining in-state defendants, especially local adjusters, to prevent insurers from removing state court actions to federal court.

Premises Owners May Obtain Exclusive-Remedy Defense Under Texas Labor Code

Entergy Gulf States, Inc. v. Summers, No. 05-0272 (Tex. August 31, 2007)

This recent case clarifies the distinction under Texas law between a premises-owner and a "General Contractor" and holds that an owner acting as its own general contractor may obtain the protection under the Texas Labor of restricting an injured employee's remedies to workers' compensation benefits.  John Summers worked as the employee of International Maintenance Corp. (IMC) which contracted to perform construction and maintenance at Entergy Gulf States's plant.  The parties' contract provided that Entergy was a statutory employer that would procure workers' compensation coverage for IMC's employees.

Section 406 of the Texas Labor Code provides that a "general contractor" may enter a written contract to provide worker's compensation coverage for a subcontractor's employees, which makes the general contractor the employer of the subcontractor's employees for purposes of the workers' compensation laws.  A "general contractor" is defined as "a person who undertakes to procure the performance of work or a service, either separately or through the use of subcontractors." (Tex. Labor Code Sec. 406.123 (e)).

The lower appeals court had followed earlier cases and held that a general contractor had to enter a prime contract with another [an owner] and then agree to subcontract all or part of that work to a subcontractor.  This interpretation was based on language in the Labor Code that was changed in 1993 revisions when the Code was recodified, ostensibly "without substantive change."  Nevertheless, the Texas Supreme Court held that a court must give effect effect to a statute's clear and specific wording despite a generic statement disclaiming substantive changes.  The current statute contains no limitation on the definition and permits an owner to qualify as a general contractor on its own behalf.

Accordingly, it is now clear that premises owners may contract with contractors and obtain the benefits of the exclusive remedy of the the workers' compensation laws.

Court Finds Exceptions to Texas' Strict 8-Corner Rule

Roberts, Taylor and Sensabaugh, Inc. v. Lexington Insurance Co., H-06-2197 (S. D. Tex. Sept. 5, 2007)

Texas is probably the strictest follower in the nation of the so-called 8-corner rule that an insurer's duty to defend must be determined without reference to any extrinsic evidence beyond the 8 corners of the lawsuit complaint and the insurance policy.  The Texas Supreme Court declined to apply any exception to this rule in GuideOne Elite Ins. Co. v. Fielder Road Baptist Church, 197 S.W.3d 305 (Tex. 2006) where the complaint alleged that a youth minister accused of sexual improprieties was employed by the insured church during the policy period, but extrinsic facts would have shown that he was fired before the policy began.  Other cases have left policyholders without coverage even though extrinsic facts would have established a duty to defend.  (See Good for the Gander.)

However, the GuideOne Court did not absolutely close the door on possible exceptions, and the federal Fifth Circuit Court of Appeals has suggested that Texas law would allow extrinsic evidence where "[I]t is initially impossible to discern whether coverage is potentially implicated and when the extrinsic evidence goes solely to a fundamental issue of coverage which does not overlap with the merits of or engage the truth or falsity of any facts alleged in the underlying case."  Northfield Ins. Co. v. Loving Home Care, Inc., 363 F.3d 523, 531 (5th Cir. 2004).

In the recent Roberts, Taylor case, a general contractor hired a sub on a municipal project, requiring the sub to procure insurance naming the general as an additional insured for liability arising from the sub's work on project.  The sub in turn hired a sub sub, whose employee was injured and sued the general.  The lawsuit didn't allege any facts about the sub or for whom the employee was performing work at the time of the accident.  The sub's insurer admitted that the general was an additional insured under the policy but refused to defend because the lawsuit did not allege that the injured employee of the sub sub was working on a project for the sub or that the sub was working for the general.  The additional insured general naturally asked the court to recognize an exception (or two) to the strict 8-corner rule and admit evidence that the sub sub's work was within the scope of the sub's covered work.

The federal district court decided that this situation met the criteria justifying the exceptions suggested in the Loving Home case.  The pleadings were silent on the applicable subcontracts under which the sub sub's employee was working, and evidence of these subcontracts would not engage the truth or falsity of the plaintiff's allegations.  Therefore, the insurer had a duty to defend the additional insured.

However, in reaching its decision, the court ignored the insurer's argument, which appears to be a good one, that the evidence of the general's contract with the sub did in fact engage the truth or falsity of the allegations in the complaint, in the same way that the actual termination date of the youth minister affected the church's liability in the GuideOne case.  If the general had no subcontract with the sub, wouldn't that affect the general's legal liability to a sub sub's employee?  Arguably, the Roberts, Taylor decision raises more problems than it solves about how Texas courts should view possible exceptions to the 8-corner rule.

Judge Dismisses Antitrust Claims Against Insurers and Brokers Over Alleged Contingent Fee/Bid Rigging Practices

A federal district court judge in New Jersey ended a huge antitrust lawsuit against dozens of the nation's largest insurance companies and brokers alleging conspiracy to allocate customers and fix prices.  Policyholders, both corporate and individual and interested public agencies brought the lawsuit concerning practices first scrutinized by the New York Attorney General in 2004 in which certain insurance brokers allegedly received undisclosed or inadequately disclosed commissions, so-called "contingent commissions," from insurers for preferential placement of business and solicited phony bids from some insurers in bid-rigging schemes.  Since 2004, many brokers have promised to cease taking contingent commissions, and RIMS, a national association of risk managers, has condemned the practice.  See RIMS.  Moreover, many of the participants have paid regulators millions in settlements.  See, e.g., Marsh settlement.

The Judge Garrett E. Brown Jr threw out the lawsuit writing that the "hub and spoke" conspiracy "is devoid of a factual basis for this court to infer that an agreement existed among the competitors - in this case, the insurer defendants."  The plaintiffs failed to show a horizontal agreement among the insurer defendants to divide the brokers' business and refrain from competition.  Judge Brown also concluded that the plaintiffs failed to demonstrate a global conspiracy among the broker defendants to hide the existence of "contingent," or bonus, commissions from their own clients, or the clients of another broker in an effort to steal that broker's clients.  For a fuller discussion of this dismissal, see Judge Again Dismisses Lawsuit.

Texas Insurance Code Delay Penalty Held Applicable To Defense Costs

Lamar Homes, Inc. v. Mid-Continent Casualty Co., #05-0832 (Tex. August 31, 2007)

In addition to deciding important insurance coverage issues regarding liability insurers' duty to defend construction defect lawsuits (see discussion at CGL Coverage of Construction Defects), the Texas Supreme Court also decided a 7 year controversy over the application of a statutory penalty imposed on insurers that delay handling and payment of "first party claims."  Article 542 (formerly 21.55) of the Texas Insurance Code allows policyholders to exact damages of 18% per annum for insurers' missing specific deadlines, including payment, of "first party claims," those "made by an insured or policyholder under an insurance policy or contract or by a beneficiary named in the policy or contract that must be paid by the insurer directly to the insured or beneficiary." 

This provision clearly applied to claims under first-party policies, such as homeowners and fire insurance.  Courts also readily applied the penalty to the underinsurerd/uninsured coverage in auto policies (although part of the liability component of an auto policy, the payment of UM/UIM damages is made directly to the policyholder).  What about liability insurers' obligation to pay defense costs for policyholders in defending covered lawsuits?  Is that a "first party" obligation?   The Lamar Homes Court says yes.

Texas courts have split.  Beginning with Sentry Inc. Co. v. Greenleaf Software, Inc., 91 F. Supp.2d 920 (N.D. Tex. 2000), some courts have agreed with the policyholder that, although the obligation to indemnify or pay damages or settlements on behalf of insured is third-party, payment of defense costs is first-party.  Damages are paid to the claimants; defense costs are paid to the insureds' lawyers.  Insurers countered by arguing that the Legislature never intended for the penalty to apply to CGL or other third-party type policies.  Also, applying art. 542 to the duty to defend was unworkable because the statutory deadlines are tied to specific acts, primarily payment of a demand for money.  A policyholder's request for a defense is not a demand for payment of a specific sum as much a invoking the right to require such payment in the future.  This was the primary basis for the Dallas Court of Appeals decision rejecting the insured's 542 claim in TIG Ins. Co. v. Dallas Basketball, Ltd., 129 S.W. 3d 232 (Tex. App.- Dallas 2004).

In Lamar Homes, the Court held that the obligation to pay defense costs was first-party in nature, so art. 542 would apply to delayed payment of defense costs under liability policies.  The Court recognized the problem raised by TIG but did not elaborate or provide a solution.  See Lamar Homes Decision.  Moreover, the dissenting opinion did not even raise the 542 issue.  Therefore, policyholders may seek recovery of delay damages for covered defense costs when the insurer misses one of the statutory deadlines (e.g., written acknowledgment of the claim within 15 bus. days, payment at least after 60 days).

What are the practical implications?  First, the threat of an 18% additional penalty should pressure insurers to offer to defend more claims than before, if only under a reservation of rights.  Many issues remain unresolved, but it would appear that an insurer who refuses to defend and later loses a coverage contest will have to pay the 18% penalty.  The safer course for insurers will be to pay defense costs but reserve rights to contest coverage for settlements or judgments.

Second, policyholders will have to heed the warning of TIG.  The clock will probably not begin on the running of the 18% until the insurer's failure to pay an actual invoice submitted to the insurer for payment.  In other words, sending a demand for defense at the outset of litigation will not trigger the deadlines under art. 542.  Only when defense cost invoices are sent does the insurer have to calendar the required responses and payment.  A good illustration of this is the Greenleaf Software case mentioned above, in which the insured demanded a defense in 1997.  After the insurer refused to defend, the insured defended itself in the underlying case and eventually settled the case.  Approximately 12 months after first demanding a defense, the insured forwarded all of the defense costs invoices to the insurer along with the settlement and demanded payment of all of it.  The court ruled that art. 21.55 (now 542) applied to the defense invoices, and the 18% began to accrue the earlier of 60 days after the invoices were submitted in 1998 or the date the coverage lawsuit was filed.  Policyholders are advised to review the statute carefully and tailor demands for payment to the language of the statute.