Law and Insurance

Bear Stearns Bungled Insurance Coverage Before Collapse

Vigilant Ins. Co. v. The Bear Stearns Cos., 2008 N.Y. LEXIS 542 (N.Y. March 13, 2008).

No question, Bear Sterns blew it.  Sadly, however, Bear Stearns is not alone in failing to heed insurance policy obligations to get the insurer's consent before agreeing to a settlement. 

Bear Stearns purchased a professional liability policy from Vigilant that arguably would have covered some of an $80 million settlement with various government agencies over alleged improper conflicts of interest in its financial services business.  After extensive negotiations with the regulators, Bear Stearns signed a consent agreement acceding to entry of a judgment for injunctive and monetary relief, approximately $45 million of which was arguably covered under the liability policy.

Unfortunately, Bear Stearns did not notify Vigilant of the proposed settlement until after execution of the consent agreement.  Vigilant raised several defenses to coverage, including violation of a common policy consent provision:

The insured agrees not to settle any Claim, Incur any Defense Costs or otherwise assume any contractual obligation or admit any liability with respect to any Claim . . .

In the coverage lawsuit following Vigilant's denial, Bear Stearns argued that the settlement was in fact not final because it was subject to court approval.  The high court of New York rejected this argument.  The consent agreement was final as far as Bear Stearns was concerned.  It acknowledged that the SEC could present a final judgment to the federal court for signature and entry without further notice.  "In short," observed the Court, "Bear Stearns did everything within its ability to settle the matter and no further action was required on its part."

Bear Stearns was managing its own defense within a substantial retention.  This is very common.  But it is vitally important to keep the insurer informed both when lawsuits are filed and when settlement negotiations are under way.  Somebody, Bear Stearns' risk management or outside litigation counsel, dropped the ball on this one.

Liability Insurer Has No Duty To Inform Additional Insured That Coverage Exists

National Union Fire Ins. Co. v. Crocker, #06-0868 (Tex. Feb. 15, 2008) see Crocker Opinion.

The old adage, "Hard facts make bad law" applies in this case.  A nursing home resident sued the facility and an employee after being injured when the employee allegedly swung open a door and hit the resident.  The employee never answered the lawsuit, and apparently never knew he was covered under the employer's policy.  A jury found that the nursing home, acting "by and through its agents acting within the course and scope of their employment," was not negligent.  The plaintiff's attorney moved to sever the defaulting employee before verdict.  After the take-nothing judgment in favor of the nursing home, the plaintiff obtained a $1 million default judgment against the employee and sought to collect against the nursing home's insurance company.

You see, the insurer knew all along that the employee was an "omnibus" or additional insured under the policy.  The insurer had tried to contact the employee by phone and certified mail regarding his status as an insured and right to a defense under the policy.  Apparently, the attorney hired by the insurer to defend the nursing home tried to speak to the employee at a deposition, but the employee refused to speak to him.  So no wonder that the insurer denied responsibility for the default judgment based on the employee's failure to notify the insurer or send a copy of the lawsuit as the policy required.

When the insurance coverage suit reached the 5th Circuit, the court certified the question to the Texas Supreme Court as follows:

Where an additional insured does not and cannot be presumed to know of coverage under an insurer's liability policy, does an insurer that has knowledge that a suit implicating policy coverage has been filed against its additional insured have a duty to inform the additional insured of the available coverage?

The 5th Circuit also asked if the insurer's actual knowledge of these circumstances establishes lack of prejudice as a matter of law. 

The Texas Supreme Court answered No to both questions.  "[A]n insurer that has not been notified that a defense is expected bears no extra-contractual duty to provide notice that a defense is available to an additional insured who has not requested one."  On the question of whether or not the insurer was prejudiced, the Court distinguished this case from PAJ, Inc. v. Hanover (see my discussion at CGL Insurers Must Prove Prejudice), in which the insured sent late notice to the insurer.  In this case, the Court stated, "[N]otice was not merely late; it was wholly lacking."

Bottom line: "Insurers owe no duty to provide an unsought, uninvited, unrequested, unsolicited defense."

But the facts in Crocker are extreme.  National Union bent over backward to contact the employee.  A jury determined that neither the facility nor its agents (including employees) were negligent before the plaintiff obtained a $1 million default judgment.  By contrast, in most additional-insured late-notice cases, the equities are more balanced or favor the additional-insured.  For example, should the insurer avoid coverage when an additional insured requests coverage during the investigation phase before a lawsuit is actually filed but after the plaintiff has demanded relief?  There may even be extensive pre-suit communications between the additional insured and the insurer in which the former's intent to seek coverage is clear.  As the Crocker Court observed, the insurer's duty to defend is not actually triggered until the lawsuit is filed and conveyed to the insurer.  Yet, if the additional insured fails to forward the lawsuit but continues to correspond about the claim, would the Crocker Court excuse the insurer or call it an unsought, uninvited, unrequested, unsolicited defense?

It appears likely that the PAJ decision will require the insurer to show prejudice before avoiding this type of coverage, which means that, as long as the additional insured sends a complaint (or amended complaint) to the insurer and requests a defense within a reasonable time before trial (some decisions have held that a month or two is reasonable), the duty to defend will be triggered. 

But it is clear that ignorance of one's additional-insured status is no excuse.  That is bad news for so-called "omnibus" insureds, like employees of a named insured company, who do not contract for their additional-insured status and so probably have no idea of their rights to coverage.  For those who become additional insureds by contract with the named insured, simply because the named insured is being defended in a lawsuit, does not mean that the insurer has any obligation to cover additional insureds until they send a copy of the complaint and demand defense and indemnity in their own right.

"Tension in the Duty To Defend" By Scott Stolley

In a recent article, referenced above, published in Headnotes, a publication of the Dallas Bar Association, (see Tension), Thompson & Knight Partner Scott Stolley identifies four unsettled areas in Texas law governing an insurer's duty to defend.  These include:

• Extrinsic Evidence
• Selection of counsel
• Recoupment of Costs
• Prompt Payment

The Texas Supreme Court recently addressed two of the areas of concern (See Frank's Casing and PAJ Inc.).  Nonetheless, many of the details, raised in Stolley's article, remain to be worked out in subsequent cases.  Worth the read. 

CGL Insurers Must Prove Prejudice To Avoid Coverage For Late Notice of Claims

PAJ, Inc. v. Hanover Ins. Co., No. 05-0849, (Tex. January 11, 2008)

This decision puts Texas squarely in the national majority position on what happens when the insured fails to give its liability insurer timely notice of a claim or suit.  It is now clear that in all types of claims, the insurer may not refuse to defend or indemnify the insured unless the delay prejudiced the insurer's rights under the policy.  However, this decision probably does not require the insurer to prove prejudice for late notice under a claims-made type policy.  (For more information on claims-made policies, see Late Notice Under Claims-Made Policy).

Standard Commercial General Liability (CGL) occurrence-type policies require the insured to send notice of a claim or suit "as soon as practicable"  (how soon varies with the facts of each case, but most courts require notice within a couple of months).  Before 1973, under Texas law, failure to do so resulted in forfeiture of coverage for that claim, without regard to any evidence of actual prejudice to the insurer.  The State Board of Insurance issued a 1973 order requiring CGL policies to preclude forfeiture of the claim unless the insurer is prejudiced by the late notice but only for bodily injury or property damage (which in 1973 is all that a standard CGL policy covered.  Later, CGL policies began covering what is now called "personal and advertising injury," at issue in the PAJ case).  Between 1973 and the present, Texas courts have split between holding that the insurer must prove prejudice in all cases or just in bodily injury/property damage cases. 

PAJ, Inc. is a jewelry manufacturer that was sued for copyright infringement, that qualified for coverage as an "advertising injury" under its CGL policy.  Apparently not realizing that the lawsuit might be covered by insurance, PAJ failed for four months to send Hanover notice of the lawsuit (PAJ stipulated that notice was not "as soon as practicable").  Hanover denied coverage but stipulated in court that the delayed notice did not cause prejudice.  The lower courts held that Hanover had the right to deny coverage without having to prove prejudice because the notice clause constituted a "condition precedent," not a "covenant."  And this is the legal distinction that the Texas Supreme Court had to parse.

A "condition precedent" in a contract is a condition that must be met before performance is due.  The "condition precedent" is viewed legally as an essential basis for the contract, at the heart of the bargain.  For example, suppose I want to donate land to a city to be used as a park.  If I grant the land to the city but only for so long as it is used as a recreational park, this is a condition precedent to my gift.  The grant is rescinded if the city tries to develop condos on the land.  If the condition precedent fails, the contract (or land grant in this case) fails.

A "covenant," by contrast, is simply a promise or obligation.  A contract usually contains a number of covenants.  In an insurance contract, the insurer promises to pay money or take certain action upon the occurrence of covered risks; the insured agrees in return to pay a premium.  The policy contains other terms and provisions that further define the parties' obligations, in light of anticipated circumstances that affect the contract.  The key distinction about covenants is that a party's performance may in some respect fall short of what was promised, but unless it materially affects the fundamental purpose of the contract, the deficiency will not result in a complete forfeiture of the bargained-for exchange.  Breach of a covenant may be material or immaterial.  If the breach is material, the breaching party may lose the benefit of the bargain.  If immaterial, then the breach may be overlooked or require only a reasonable modification.

Is the notice obligation a condition precedent or a covenant?  Often it looks like a condition precedent when it uses conditional language, such as [insurer will cover the claim] "unless" or "unless, as a condition precedent thereto," [notice is not given as soon as practicable].  In PAJ, the Supreme Court appeared to cut the Gordian Knot of arcane legalese and hold that it would treat these notice provisions as covenants regardless of the phraseology used.  In doing so, the Court recognized it was following the modern trend in favor of requiring proof of prejudice.

PAJ drew a spirited dissent joined by three other justices condemning what was perceived as a departure from established law on the interpretation of conditions precedent.  The dissent pointed out that the insurance industry recently changed the standard CGL policy by including an endorsement requiring prejudice for personal and advertising injury claims as well as bodily injury/property damage claims.  It if for legislative bodies or the contracting parties, not the courts, to alter the policies, says the dissent.

The PAJ decision brings a measure of certainty to the claim analysis when notice is delayed.  Policyholders in fact have an incentive to provide timely notice to their insurers, who have no obligation pay defense costs incurred before they receive notice.  So, I do not think this decision will result in tardier habits among risk managers.  Also, as mentioned before, courts will not require insurers under claims-made policies to show prejudice, at least as long as notice is sent within the policy period.

5th Circuit Asks Texas Supreme Court To Clarify Prejudice Requirement For Late Notice Under Claims-Made Policies

Note: the following question may have been resolved by the subsequent Texas Supreme Court decision in PAJ, Inc. v. Hanover Ins. Co., 05-0849 (January 11, 2008) holding that an insurer must in all cases show prejudice caused by late notice when the insured fails to give notice "as soon as practicable."

XL Specialty Ins. Co. v. Financial Indus. Corp., No. 06-51683 (5th Cir. December 19, 2007).  See text of opinion at Certified Question.

The federal appellate court here certifies to the Texas High Court an interesting and murky question about a liability insurer's duty to defend a lawsuit even though the policyholder breached the claims-made policy requirement to give the insurer notice of the claim "as soon as practicable after it is first made."  A most suitable problem with which to end 2007.

The insured's management liability policy covered liability for specified conduct but only if the claim against the insured was made within the policy period, in this case between March 12, 2005 and March 12, 2006, and reported promptly to the insurer, as stated above.  Financial was sued on June 5, 2005 for breach of contract and fraud (assume this is covered conduct) but failed to send XL notice of the lawsuit until early January 2006, seven months after the claim was made but within the policy period.  Both parties stipulated in court that the notification breached the prompt-notice requirement in the policy but did not prejudice XL. 

The 5th Circuit judges recognized that Texas law was settled on two issues:

1. Concerning claims based on bodily injury or property damage, breach of a late-notice clause would not excuse a liability insurer's obligation to defend unless the insurer could show that the breach was material, i.e., caused prejudice to the insurer's rights under the policy; and
2. Under a claims-made type policy, an insured's failure to provide notice of a claim within the policy period (or any allowed reporting period after expiration of the policy) automatically excused the insurer from having to defend or indemnify the claim.

The distinction between an "occurrence" type and a "claims-made" type policy is crucial to understanding the court's dilemma in this case.  "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). 

Courts generally have recognized that, in the absence of actual prejudice to the insurer, late notice of a claim or lawsuit under an occurrence policy is generally less significant than under claims-made policies because a central benefit-of-the-bargain to the claims-made insurer is the certainty of a relatively short window of exposure to risk.  After the policy period expires (and any specified reporting period, usually a month unless a longer reporting period is purchased), the insurer can close its books on the policy.  However, the occurrence policy theoretically must be left open forever, as some insurers of asbestos and pollution risks know all too well.  The insured company that can find the old occurrence policy from half a century before can demand coverage as long as the lawsuit alleges that the pollution or asbestos exposure fell in part within the policy period.

With that distinction in mind, courts will not allow an insured to sit on a claim until after the claims-made policy is over and then send late notice to the insurer.  Even if this insurer cannot prove that it was prejudiced by the late notice, courts draw a bright line at the termination of the policy period because closure of risk was a central right the claims-made insurer bargained for (if one can say insurance policies are the result of bargaining).  Prompt notice to the occurrence insurer is arguably less of a central concern, as long as no prejudice results.

But what about the case at issue?  What if notice is given within the policy period of a claims-made policy but not "as soon as practicable"?  And what if the claim does not arise from bodily injury or property damage, as in this case?  (The XL court noted a split among Texas appellate decisions, some holding that prejudice must be shown in all cases, and others restricting the prejudice requirement strictly to bodily injury/property damage cases, including one currently on review before the Texas Supreme Court holding that advertising-injury claims do not require a showing of prejudice).

Thus:  "We certify the following determinative question of law to the Supreme Court of Texas: 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?"

With any luck, we will have the Supreme Court's answer before New Years Day 2008.

Insurers Lose First Challenge to "Known Loss" Exclusion in CGL Policies

Transportation Ins. Co. v. The Regency Roofing Cos., Inc., 2007 U.S. Dist. LEXIS 74364 (S.D. Fla. Oct. 2, 2007)

This is the first test case of the so-called "known loss" exclusion that has been written into most standard commercial general liability  (CGL) policies for about five years.  This exclusion bars coverage for any "bodily injury" or "property damage" that any insured knew had occurred or begun to occur before the inception of the insurance policy.  As the court put it, "In other words, to be covered, the Insured must have been unaware of any property damage prior to the Policy period, and must have first learned of such damage during the term of the Policy."

The rationale behind this exclusion is simple and reasonable: you can't wait until your house burns down to go out and buy fire insurance.  Courts have always refused as a matter of public policy to allow insurance coverage for a "known loss."  However, over the last decade or so, the insurance industry has pressed this doctrine aggressively, as the facts of this case illustrate. 

Regency Roofing was hired in 1999 to re-roof a large residence that included 11 flat roofs.  Over the course of the the following two years or so, Regency was called back several times to fix leaks around skylights and flashing.  On at least one occasion, the contractor reported rust in an air conditioning duct.  In January 2002, the homeowners sued Regency for alleged property damage, including mold damage, arising from faulty repairs.  Regency submitted the claim to its CGL insurer, who challenged coverage under the "known loss" exclusion.  The insurer argued that Regency had sufficient awareness of the roof leaks prior to the inception date of the CGL policies (Transportation issued several consecutive policies) to trigger the exclusion.  The court disagreed.

The court held that even if some of the damage is excluded, either because Regency knew about it before the policy period or because of other exclusions, the homeowners did not complain of mold damage until after the first CGL policy began.  Accordingly, the court denied the insurer's motion for summary judgment. 

The "known loss" exclusion is a potential trap particularly for building contractors who make several attempts to cure a problem hoping to satisfy the customer and so do not report the complaint to their insurer until the customer's patience wears thin and a lawsuit is filed.  By then, the "known loss" exclusion may bar coverage.  An illustration of this dilemma is Blanton v. Vesta Lloyds Ins. Co., 2006 Tex. App. LEXIS 1823 (Tex. App.---Dallas, March 9, 2006), in which a commercial landlord, insured under a standard CGL, leased an older structure to a retail tenant, who experienced problems with the roof.  The Tenant said the roof leaked whenever it rained and complained more than 80 times over a 2 and half year period before filing lawsuit.  Landlord attempted to fix the roof after each complaint.  Suit was filed October 24, 2000, and Landlord submitted the petition on December 6, 2000. 

The insurer in the Blanton case sought to avoid coverage under a late-notice theory rather than known loss, but the problem is similar.  Policyholders usually do not submit claims until there is a lawsuit against them.  In fact, the CGL insurer arguably has no legal duty to take any action until suit has been filed (policies vary on this).  But waiting until the lawsuit is filed may put coverage at risk because of late-notice or known-loss defenses. 

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5th Circuit Asks Texas Supreme Court To Determine Effect of Actual Notice When Insured Fails To Forward Lawsuit

Note: Texas Supreme Court answered this question in the negative (see my discussion at Crocker Opinion).

Crocker v. National Union Fire Ins. Co., 466 F. 3d 347 (5th Cir. 2006)

Two Texas federal district courts have reached opposite answers to the following question: When the insured is sued and fails to send a copy of the lawsuit to the liability insurer as required by the policy, may the insurer refuse to cover the claim or defend the lawsuit, even though the insurer had actual knowledge of the lawsuit?  The US District Court for the Western District of Texas said no in Crocker.  However, recently, in East Texas Medical Center Regional Health System v. Lexington Ins. Co. (E.D. Tex. July 12, 2007), a court in the Eastern District said yes.  So the 5th Circuit wants the Texas High Court to sort it out.

The facts of the two cases are somewhat different, but the fundamental question is, I believe, the same.  In Crocker, a nursing home employee allegedly injured a patient who sued both the employee and the nursing home.  The nursing home's liability policy also covered the employee as an additional insured.  Unfortunately, the employee was fired soon after the accident and did not know that he was entitled to a defense from the insurer.  The insurer and the attorney it hired to defend the nursing home had a copy of the lawsuit and knew that the employee was a defendant.  Indeed, the attorney even deposed the employee.  Yet no one told the employee that he was entitled to a cost-free defense.  Despite some attempts to contact the employee, the insurer admits that it never told him the insurer would provide a defense.  The case resulted in a judgment against the employee, which the insurer refused to cover because the employee failed to forward a copy of the lawsuit to the insurer.  The lower court ruled in favor of coverage based on the insurer's actual knowledge of the lawsuit.

East Texas Medical Center (ETMC) had a claims-made malpractice liability policy under which it was responsible for paying and handling the first $2 million of covered claims.  The policy nonetheless required ETMC to provide notice of claims and copies of lawsuits to the insurer.  It was ETMC's practice to enter new claims and track their progress in a computer database made available to the insurer.  The claim in question was asserted and recorded a few weeks before the policy expired.  At first, ETMC did not think the claim would exceed its $2 million deductible.  Several months after the policy expired, however, ETMC learned at a deposition the serious nature of the injuries and sent written notice to the insurer, who denied the claim.  The court in the coverage lawsuit found that ETMC breached the policy by failing to forward suit papers to the insurer within the policy period, as required by the claim-made policy.  The court held that the insurer's actual awareness of the claim from the database did not excuse the insured from having to send the insurer the lawsuit.  Further, the court refused to consider whether the insured's failure prejudiced the insurer because of the claims-made nature of the policy (i.e., courts routinely hold that an insurer does not need to prove that failure of notice prejudiced the insurer's interests.)

Risk managers of companies that self-insure substantial layers of liability risk should take special note of the ETMC case.  I have noticed that many risk managers are reluctant to report claims where, as in this case, the insured is responsible for investigating and paying most small claims.  Too often a sleeper claim comes along which doesn't loom large as a multi-million risk until well into litigation.  Then it may be too late.  Most insurance companies will assert notice defenses available to them.  The best advice is to notify early and often.

House Committee Takes a Step Closer to Renewing Terrorism Reinsurance Bill

A week after the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises voted to extend the federal terrorism reinsurance law (see my post at Subcommittee Action), the House Financial Services Committee voted 49 to 20 to extend the 2002 legislation for an additional 15 years against the desires of the Bush administration.  If passed, H.R.2761 will expand federal participation in backstop insurance coverage losses caused by domestic as well as foreign acts of terrorism and will include coverage against nuclear, biological, chemical and radiological attacks, a provision not welcome by all insurers. 

The Bush Administration has opposed attempts to continue and expand the government program, while the insurance industry has been largely supportive, and argues that the federal backstop is necessary for the private market to be able to insure properties in locations at high risk of a terrorist attack.  The administration has urged that the government should not continue to be involved in the private market.  For a fuller discussion of this matter, see Insurance Journal.

Good for the Gander—Strict “Complaint Allegation” Rule Not Always Beneficial for Policyholders.

Sentry Insurance v. DFW Alliance Corp., 2007 U.S. Dist. LEXIS 15645 (N.D. Tex. March 6, 2007)

Posted by David S. White

The Texas Supreme Court’s holding in GuideOne Elite Ins. Co. v. Fielder Rd. Baptist Church, 197 S.W.3d 305, 308, (Tex. 2006), that a liability insurer’s duty to defend must be determined strictly under the “complaint allegation” or “eight-corners” rule, was generally greeted by policyholders as a victory and by insurers as a defeat.  However, the recent DFW Alliance Corp. case shows that the rule can just as easily work against finding coverage.  The “complaint allegation” rule provides that an insurer’s duty to defend the policyholder defendant in a lawsuit must be determined strictly from the terms of the insurance policy and the allegations in the complaint.  A court should not consider evidence outside the eight corners of those two documents, even if the allegations are inaccurate, groundless, or frivolous.

In GuideOne Elite, for example, a church youth minister was accused of sexually abusing the plaintiff at the church from 1992 to 1994.  The church’s insurance policy, which covered the alleged abuse, was issued effective March 1993 to March 1994, so the insurer appeared to owe a defense.  In fact, however, the youth minister ceased employment with the church in December 1992. The insurer sought to introduce evidence of this fact to prove that the alleged conduct occurred before the policy period which meant it had no duty to defend the lawsuit.  The courts, including the Texas High Court, said no.  Extrinsic evidence not alleged within the four corners of the complaint was not admissible to determine the insurer’s duty to defend. 

The DFW Alliance Corp. case shows that the complaint-allegation rule can just as easily work against the policyholder.  The underlying plaintiff in that case sued DFW Alliance for copyright infringement and alleged that the company began infringing at least two years before the policy period.  The insurer denied coverage on several bases, including what is called the fortuity or “known loss” doctrine, which prohibits someone from, say, running out the day after his house burns down and buying fire insurance.  If the insured is aware when he buys the insurance that the loss already exists or is in progress, the coverage is void as a matter of public policy.

The court in DFW Alliance held that the complaint alleged that the insured was engaged in the infringing conduct before the policy was issued and granted summary judgment for the insurance company.  The policyholder tried to argue that it could produce evidence showing that it in fact had not engaged in the infringing conduct before the policy period.  However, relying on the cases cited above, the court held that extrinsic evidence was not admissible.  The court could only consider the pleading and the policy.