Law and Insurance

Texas Supreme Court Resolves Late Notice Conundrum Under Claims-Made Policies

Prodigy Communications Corp. v. Agricultural Excess & Surplus Ins. Co., # 06-0598 (Tex. March 27, 2009) see Prodigy Decision.

A little over a year ago, the Fifth Circuit Court of Appeals certified a question to the Texas Supreme Court (see my discussion at 5th Circuit Asks Texas Supreme Court to Clarify Prejudice Requirement for Late Notice Under Claims-Made Policies) , which it answered last week in the Prodigy case.  The question was:

Must an insurer show prejudice to deny payment of a claims-made policy, when the denial is based upon the insured's breach of the policy's prompt-notice provision, but the notice is nevertheless given within the policy's coverage period?"

The High Court, over three dissenting Justices, held that the insurer must prove prejudice under these circumstances, even though the policy is claims-made.  The distinction between an "occurrence" type and a "claims-made" type policy is crucial.  "Occurrence" policies cover the insured's liability for claims asserting that the covered accident, event or conduct (the "occurrence") occurred within the policy period, without regard to when the claim was actually asserted or the lawsuit filed against the insured.  By contrast, "claims-made" policies respond to claims asserted against the insured within the policy period, without regard to when the event or conduct occurred giving rise to the claim (although most claims-made policies impose a retroactive date limiting how far into the past the coverage will extend).

The Texas Supreme Court had earlier put to rest any dispute over the insurer's obligation to demonstrate that late notice caused prejudice under an occurrence type policy in the PAJ case (see discussion CGL Insurers Must Prove Prejudice to Avoid Coverage for Late Notice of Claims).   By holding that the insurer must show prejudice for late notice, as long as notice is still within the policy period or any extended reporting period, the Prodigy decision seems to resolve the issue fairly.

On the one hand, the claims-made insurer retains the benefit of its bargain by being able to curtail further claims at the end of the reporting period.  On the other hand, requiring the insurer to show that the delay actually prejudiced its interests prevents a harsh forfeiture of coverage yet still protects the insurer's interests.

The dissenters argued that requiring a demonstration of prejudice in effect rewrites the policy.  But that argument was aired and discarded in the PAJ case. 

The effect of Prodigy is that notice of a claim must now be given within the time allowed for reporting claims under the policy even if the policy requires notice as soon as practicable.  Failure to provide prompt notice shifts the burden to the insurer to show that the delay actually caused prejudice.

1st Circuit Court Limits "Known-Loss" Defense to Actual Adjudication

Employers Reinsurance Corp. v. Globe Newspaper Co., #08-1733 (1st Cir. March 19, 2009), see Globe Decision.

"Known loss" or "fortuity" is a cornerstone principle of insurance.  The starkest example: a homeowner may not run out and buy fire insurance after the house burns down, or while it is still burning.  Public policy forbids insuring a loss that the insured knows has occurred or is in progress.  However, the fortuity principle has been stretched in the last 20 years, in some instances, beyond reasonable limits.  The Globe Newspaper decision may help puts the brakes on an out-of-control coverage defense.  The facts are these:

Beginning in March 2005, Globe began a series of articles criticizing a cancer treatment facility and one of its doctors for a tragic overdose of two patients with a chemotherapy drug.  One of the patients, a Globe columnist at the time, died.  The paper stated that one of the doctors was a leader of the team administering the drug and countersigned the order for the mistaken overdose.  In fact, however, that doctor had not treated the patient until after the overdose.

A few days after the Globe story, an attorney for the doctor contacted the paper and complained that the named doctor had not countersigned the order or directed treatment before the overdose.  The paper investigated and confirmed the doctor's innocence.  Rather than retract that portion of the story, however, the paper merely reported that a representative for the doctor said she had not been involved.  In May, the attorney wrote again to complain that the correction was inadequate and suggested that it would be "an appropriate time to discuss how the Globe will compensate [the doctor's] damages.

On June 4, the paper ran a correction admitting that the doctor had been incorrectly identified as the one countersigning the order.  However, the request for damages was not withdrawn.  On October 12, the paper applied for insurance coverage without identifying the doctor's demand.  The application identified past and pending litigation and noted that the paper received many threats from people seeking to have more favorable press, and it was difficult to separate the inconsequential threats from the serious ones.  The policy issued on October 20, 2005 with coverage for libel.

The series of articles continued, some still mentioning the same doctor, who sued the paper for libel in February 2006.  The insurer apparently agreed to defend the action subject to a reservation of rights to later deny coverage on a number of grounds, including that the alleged loss was in progress when the policy issued.  The paper suffered a sanction order when it refused to disclose confidential sources and sustained a judgment, upheld on appeal, for over $2 million.  Meanwhile, insurer had filed a coverage action seeking a declaration that it had no duty to defend or indemnify.  To its credit, the insurer paid the judgment subject to its right to reimbursement if coverage did not exist.  (N.B., an insurer could not do this in Texas.  See my discussion, Frank's Casing Decision).

The lower court granted summary judgment in favor of the insurer based on its fortuity defense.  After all, the court reasoned, the paper had received the request for damages by letter months before applying for the policy.  The First Circuit Court of Appeals reversed.

Acknowledging that the Massachusetts Supreme Judicial Court had followed the majority of states in adopting the fortuity defense, the appellate court held that an insurable risk could be eliminated only "in the instance where an insured knows, when it purchases the policy, that there is a substantial probability that it will suffer or has already suffered a loss" (quoting SCA Serv. , Inc. v. Transp. Inc. Co., 646 N.E.2d 394, 397 (Mass. 1995)) Emphasis added.  In the SCA case a court had already ordered the insured city's town dump to be closed as a nuisance, and residents had already made claims.  Thus, the court found that the city knew actual losses had occurred and were substantially certain to continue when it bought the insurance.

The Globe, said the court, may have been aware of the request for damages, but litigation had not been filed.  "The loss here may have been likely, but it was not substantially certain or known by the Globe to be so when the policy was obtained."  In reversing the summary judgment, however, the appellate court observed that the insurer had other defenses, not addressed by the lower court, and victory for the paper was by no means assured.

The reasoning in the Globe decision arguably limits the known loss doctrine to situations in which the loss has been, or is being, actually adjudicated.  While that may be over-reading the court's analysis, this decision should help bring some fair boundaries to the use of this doctrine.  Case in point under Texas law, in RLI Ins. Co. v. Maxxon Southwest, Inc., 265 F. Supp.2d 727 (N.D. Tex. 2003), a cement manufacturer was denied coverage for litigation alleging price-discrimination under the Robinson-Patman Act (don't ask how a company gets antitrust insurance in the first place; we have to take that on trust).  The threat of litigation as well as the subsequent lawsuit occurred after purchase of the policy.  The insurer argued that Maxxon was aware that different prices had been charged for years.  Hence, it was a continuing loss uninsurable under the fortuity doctrine. 

The lower court agreed, even though it acknowledged that that the insured had no independent knowledge of the subject loss, because the company knew different cement dealers paid different prices for their cement, so "the risk of injury was or should have been, readily apparent to the defendants."

The Fifth Circuit upheld the lower court's decision holding that the critical issue was "whether the party knowingly acted in a manner in which it could possibly be found liable."  Folks, companies charge different prices to different customers all the time.  Robinson-Patman liability is subject to numerous exceptions and is notoriously difficult to untangle, except on hindsight.  Maxxon had received no complaints, no cease and desist letter, and had no knowledge of any alleged loss. 

Perhaps Globe's actual pending adjudication is too tight a standard for all circumstances, but being denied coverage for something you know you might be liable for can't be the fortuity standard. Insurers now routinely raise the fortuity defense in just about every case in commercial litigation.  Often, a business may routinely receive customer complaints that are easily resolved or never amount to anything.    To allow an insurer to dig into the insured's complaint file and avoid coverage because a customer later actually filed a suit, should not be the standard. 

Courts should take note of the Globe decision.

A Sexual Assault By Any Other Name Isn't a Covered Occurrence, Says Court

Geovera Specialty Insurance Co. v. Finley, #4-08-CV-00275-Y (N.D. Tex. March 4, 2009)

This is probably the most unsurprising decision of the year, but it illustrates a significant distinction between the facts alleged and the legal theories asserted.  Texas courts are instructed to determine a general liability insurer's duty to defend exclusively (or almost exclusively, as discussed below) by the facts alleged in a pleading, not by the legal tags put on them.

A certain P.G. (ergo a minor) sued the insured for assault and sexual assault asserting claims for

1. "knowingly, intentionally, recklessly, and negligently" violating section 22.011 of the Texas Penal Code (prohibiting knowingly or intentionally causing any one of a dozen or so acts of penetrating, touching, or contacting variously described organs, orifices, or other parts);

2. "intentionally or knowingly" causing "physical contact with [P.G.] when he knew or should reasonably have believed that [P.G.] would regard the contact as provocative; and

3. intentional infliction of emotional distress.

The homeowner insurance company declined to defend the lawsuit and sought a coverage determination in federal court.  The policy covers bodily injury caused by an "occurrence," defined as "an accident, including continuous or repeated exposure to substantially the same general harmful conditions."  Something is an accident if it a a "fortuitous, unexpected or unintended event." (Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1, 8 (Tex. 2007)).  Something that is intended or expected cannot be an occurrence.

The insured argued that the lawsuit included allegations of negligence as well as intent.  The insured allegedly knew or should have known that the contact was offensive.  "Should have known" is legal shorthand for negligence.  However, the court held that the factual allegations were all on the intentional side of the bar.  Although the court doesn't go into detail (the only description of the factual allegations is that "Finley assaulted and sexually assaulted" P.G.), but apparently the details don't matter.  Sexual assault by definition is intentional; no other way to describe it.

However, the court also finds that sometimes the court should look at the legal theories, not the facts.  "[A]n intentional tort is not an accident, and, thus cannot be an occurrence even if the effect of the intentional tort was unintended or unexpected."  Note the first allegation listed above.  P.G.'s underlying petition alleged that Finley "knowingly, intentionally, recklessly, and negligently" violated section 22.011 of the Texas Penal Code, but the Code refers only to knowing or intentional acts.  Here is a plaintiff's attorney trying to snag coverage by pinning the negligence tag on intentional acts.  The court rejected it out of hand.  But aren't we looking at legal theories here?  This conclusion seems inconsistent with the look-at-the-facts-only principle.  If the legal theory requires proof of the insured's intent, then occurrence is impossible.  That's the rule.

However, the Texas Supreme Court may have upset this neat bright line in Zurich Am. Ins. Co v. Nokia, Inc. 268 S.W.3d 487 (Tex. 2008) (see my discussion, Nokia Decision) by holding that, when the facts unambiguously allege biological injury from prolonged cell phone use, an occurrence is alleged, even though none of the causes of action asserted had any connection with the biological injury.  The plaintiffs in that case sought to recover only the cost of headsets and monitoring.  Nokia didn't involve intentional torts, but, arguably, if the facts alleged in a lawsuit are consistent with negligent conduct but the only legal theories asserted require proof of intent, Nokia may nudge a court to ignore the legal theories and rely exclusively on the alleged facts.  That could get interesting.

Texas Court Finds Agent's "Election-of-Remedies" Defense Problematic

Horizon Offshore Contractors, Inc. v. Aon Risk Services of Texas, Inc., #14-07-00549 (Tex. App. Houston [14th Dist.] March 12, 2009), see Horizon Opinion

How can an insurance agent lose an appeal over a successful motion for summary judgment against a policyholder's claims that the agent negligently procured a marine risk policy with an English venue and choice-of-law clause (as a consequence of which coverage was not what it should have been), when the policyholder had received a copy of the policy, and Texas is a strong duty-to-read-your-own-damn-policy jurisdiction?  Although this case is a little complicated, the reason Aon failed is simple: it relied exclusively on a legal theory that the court characterized as, "a legal weed that judicial gardeners should root out, a legal delusion, an anachronism, a problem child of the law, and a remedy that has no independent viability."  The election-of-remedies defense.

Horizon hired Aon to advise it regarding insurance matters and procure policies to cover its ocean-towing business.  Aon procured two policies to cover some barges towing something flammable (one of them burned) from Texas to Israel.  The policy issued from an English insurer and required that any litigation over coverage must be brought in England under English law.  The insurer denied the claim apparently because it had not received full disclosure of details, also required under the policy, regarding the contents and crew.  Horizon sued in England and ended up settling for about half of the full limits of $28 million.  So horizon sued Aon in Texas to recover the $14 million balance of the claim and $6 million in attorneys' fees and costs.

Horizon alleged that Aon breached agency duties by procuring a crummy policy with an English venue and law-selection clause that imposed more stringent disclosure duties than Texas law would require.  Aon filed a motion for summary judgment to dismiss the case, and here we get to the election-of-remedies (EOR) defense.  The EOR defense bars relief when:

1. a party successfully exercises an informed choice
2. between two or more remedies, rights, or states of fact
3. which are so inconsistent as to
4. constitute manifest injustice

In its motion, Aon asserted that Horizon had argued in the English action that the policy was valid and enforceable because all required disclosures were made, but alleged in this suit that Aon was liable because it procured a policy that was invalid due to Aon's failure to make all required disclosures.

As stated above, the court heaped all kinds of abuse on the defense itself for various reasons.  For starters, parties are generally free to plead in the alternative facts and theories that may be inconsistent.  Also, the EOR defense tends to discourage settlement because you would never want to settle your claim against Peter based on one type of claim if it would jeopardize your claim against Paul on other legal theories or facts. 

In the final analysis, however, the court poured out Aon because Horizon's positions in the two cases were not all that inconsistent.  Horizon wasn't really arguing here that the policy was invalid, just that proving coverage was a harder row to hoe because of Aon's missteps in passing on information and getting a policy with unfavorable conditions.  Motion denied.

Back to the main point.  Does Texas law subject the agent to liability for getting a policy, which the insured accepts, when it contains an English venue and law clause?  Probably not, although I can think of facts that might tip it the other way (like telling your agent, "I hate limey insurers and their limey courts, so don't under any circumstances get me a limey policy!"  Although, even here, a court might say "duty to read").

It is hard to understand why Aon put all its eggs in one basket.  The court noted that Aon had other legal defenses.  However, it seems unlikely that Aon held back its other legal defenses.  On the other hand, this is state court, and the trial court may not require a party to shoot all its bullets in one motion.  In reversing judgment in favor of Aon, the appellate court remanded the case back to the trial court.  So we may see Horizon II in a year or two. 

Court Denies Coverage For Cost To Inspect Pipeline After Explosion

MarkWest Hydrocarbon, Inc. v. Liberty Mutual Ins. Co., #08-1186 (10th Cir. March 9, 2009) see Markwest Decision.

At first blush, the decision in this pipeline repair claim under "all-risk" property coverage appears questionable, but, as the court noted, a finding in favor of coverage "would be to convert the parties' policy against unforeseen fortuities into a maintenance contract."  In the final analysis, this case may be taken as a cautionary tale about the risks of the country's aging infrastructure.

An explosion in MarkWest's natural liquid gas pipeline near Ivel, Kentucky damaged the pipe and destroyed 5 homes in a nearby subdivision.  The pipeline was constructed in 1957.  The cause of the explosion was twofold: a valve designed to prevent a pressure buildup malfunctioned, and a small hole in a corroded patch near the valve developed as a result of excess pressure. 

At this point, one would think Markwest had a good argument for coverage because the valve failure (a covered risk) arguably caused the hole (corrosion, an excluded risk, being only an incidental contributing factor).  But read on.

The U.S. Office of Pipeline Safety (OPS) investigated and issued preliminary findings that included directions for corrective actions Markwest had to take.  The agency found extensive corrosion throughout the pipeline, in addition to the patch near the failed valve, and concluded:

[A]fter considering the age of the pipe, the proximity of the pipline to drinking water sources and populated areas, . . . the history of leaks attributed to corrosion on the pipeline, ... I find that a failure to expeditiously issue this Order requiring immediate corrective action would likely result in serious harm to life, property, or the environment.

Apparently, the pipeline had never been subject to internal inspection.  So MarkWest was ordered inspect some 65 miles of pipeline and repair or replace pipe, as appropriate.  MarkWest submitted a claim to its property insurers for these repair costs.  They denied, even though the policy covered "all risks of direct physical loss or damage occurring during the period of the policy from any external cause, except as hereinafter excluded."  As mentioned, the damage from corrosion is excluded, but the insurers didn't win on that exclusion.

The policies also excluded the "any increase in loss resulting from the use, construction, repair or demolition of any property."  An endorsement added back some coverage for the "increased cost of repair or reconstruction" of property when a covered peril causes the enforcement of a law or ordinance "regulating the construction or repair of the damaged property."  MarkWest urged that the costs of the inspection and repairs fell within the endorsement.  The court disagreed.

The court found that damage to the segment of the pipe damaged by the explosion was covered.  However, the cost to repair that segment was below the policy's $250,000 deductible.  To cover the extensive inspection and repairs ordered by the agency, the order must "regulate the construction or repair of the damaged facility." But, the court concluded:

[T]he [order] and its amendments did not require MarkWest to form, build, or "construct" anything.  [The order] required only that MarkWest test and take remedial actions to maintain the safety of a pipeline constructed over a half-century ago.  ...  OPS was hardly concerned with telling MarkWest how to repair a broken valve stem, or how to repair the broken bits of the pipeline in Ivel.  That was yesterday's problem; OPS was concerned about preventing tomorrow's.

One of the largest costs under the order was hydrostatic testing of the entire pipeline to determine its safe operating pressure.  No way should that be covered, said the court. 

Finally the court discussed the public policy implications of allowing a company to insure its regular safety maintenance obligations.  To allow companies to pass to insurers costs such as these would "encourge insureds to tighten their wallets and brush off their regular maintenance obligations."  Coverage denied.

Maybe some stimulus money.

Man Sinks Yacht and Files False Insurance Claim - Wave of the Future?

I don't know what attracted me to this story, whether it was the nautical eqivalent of road rage or the the potential trend in this economy of yacht-scuttling insurance fraud.  But there's a lesson in this somewhere.  According to a story in the Seattle Post Intelligence here, while piloting his yacht, the Jubilee, from Bainbridge Island to Seattle, a man succumbed to a fit of rage at the boat's mechanical problem and sunk the craft.  He rowed a borrowed dingy back to the island and reported the loss to his insurer, United Services Automobile Ass'n, out of San Antonio Texas, a few days later.

Things started to unravel when the state's Department of Natural Resources raised the yacht out of concern for potential environmental damage.  Insurance investigators examined the boat and found a 2-inch hole cut into the hull and some evidence of hank-panky with the bilge system.  Confronted with this discovery by federal agents, the man confessed and now faces charges for making a fraudulent insurance claim.

The man confessed in court documents that he sank his yacht because the "financial pressure and frustration" of maintaining the boat "caused him extreme anxiety." 

I don't know if this act of desperation was brought on by economic distress (he had earlier attempted to sell the craft) or just the rage of the moment, but I wouldn't be surprised to see an uptick in insurance fraud as the cost to maintain those luxury jets and yachts overtakes the once-but-no-longer wealthy.