Law and Insurance

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.

AIG Executive and Attorney Jailed Over D&O Insurance Dispute In Mexico

Now we know why there are far fewer insurance coverage disputes in Mexico than in the U.S.  The policyholder gets to file a criminal complaint for fraud and have the insurer's management taken to jail. 

Apparently, TV Azteca S.A. de C.V. submitted a claim under its Directors and Officers Insurance Policy, which the insurer, AIG Mexico Seguros Interamericana, S.A. de C.V., denied.  "Fraud!" said Azteca.  So in late April, AIG's, general manager, Luis Ferrara Perini and AIG's outside attorney, Nestor Diaz Barriga, were jailed.  Just this week, AIG apparently paid the claim and the individuals were released.  See AIG Executives Released From Jail, reported in May 5, 2008 edition of Business Insurance.

I say "apparently" because much of the story is based on comments from brokers involved in the case who, for obvious reasons, wish to remain anonymous (and unincarcerated). 

Gives a whole new meaning to Alternative Dispute Resolution.

Broad Federal Insurance Regulation To Follow?

Recently introduced, H.R. 5840, the Insurance Information Act of 2008 (see H.R. 5840 Text) will create a new Office of Insurance Information to collect and analyze data on insurance, advise the Secretary of the Treasury on foreign and domestic insurance issues, report to Congress every two years, establish federal policy on international insurance matters, and ensure consistency between state and federal insurance laws as well as coordinate international trade agreements.  The bill will also create an advisory group to inform and advise the head of the Office, which will include state regulators, consumer groups, and others in the insurance industry. 

Over all, the insurance industry appears to welcome the creation of the OII as a rational and necessary precursor to any federal action (or inaction) on future federal regulation.  For example, a senior officer of the Council of Insurance Agents & Brokers (quoted in Business Insurance Magazine, April 21, 2008) said, "There are few creative and bold acts of leadership that transform the dynamics of any insurance regulatory issue and that is precisely what has been done."  Leigh Ann Pusey, COO of the American Insurance Ass'n, observed, "We have a need to have someone at the federal level to develop some insurance knowledge and expertise and to help develop policy." 

However, not all industry voices are supportive.  Some see this measure as a first step to unwanted federal control over insurance business.  Justin Roth, senior federal affairs director for the National Ass'n of Mutual Insurance Companies, noted that the OII is the kind of agency advocated in the March 31 blueprint for financial services regulatory reform proposed by the Treasury Department.  "If you go by the Treasury Blueprint, this is step No. 1 toward an [optional national charter].  It is obvious to us that this is step No. 1, and we strongly oppose federal regulation and we have concerns that this will lead to federal regulation."

The bill does seem to point to inevitable federal regulation of some kind.  But which is worse?  Federal insurance regulation or uninformed federal regulation?