Law and Insurance

Insurer Waived Its Right To Appraisal. Why Did It Wait?

Financial Management Internat'l, Inc. d/b/a/ The Summit Sports Club v Mt. Hawley Ins. Co., #M-08-267 (S.D. Tex. Aug. 17, 2009).

The court in this case denied Mt. Hawley's Motion to Compel Appraisal because it delayed until a year into the coverage lawsuit.  The insurance dispute is over water damage at the sports club caused by a burst pipe.  The insured brought the lawsuit alleging that Mt. Hawley refused to pay for the damage.  We are not told any more than that about the coverage issues.  We are told that the insurer removed the state court case to federal case, answered complaints, attended hearings, participated in discovery and mediation, and a year into the case, sought to invoke its right to appraisal.

Appraisal is a process provided in most property policies to short cut insurance disputes over the dollar amount of damage independent of disputes over whether the claim is covered in the first place.  Once it becomes clear that the parties disagree over how much repairs or replacement costs, either party has the right to invoke the appraisal clause.  Once invoked, the clause spells out the appraisal process, which usually requires each party to select a qualified appraiser, who get together and select an umpire.  Each appraiser provides its estimate of the damage amount, and the umpire then sides with one side or the other. 

The appraisers are not supposed to decide coverage issues, only the amount to repair or replace.  Sometimes, however, it is impossible to put a dollar figure on the damage unless the scope of damage is defined.  For example, an insured's roof may have sustained both hail damage (covered under the policy) and damage from ordinary wear and tear (not covered).  In order to estimate the cost to repair, the appraisers arguably must distinguish hail damaged shingles from worn-out shingles.  This would require determining not only the cost to repair the damage but also the cause of the damage.  Texas law, however, has not clearly established that appraisers may make causation determinations.

Back to our case.  We may guess that Mt. Hawley balked at paying for the repairs because it had a causation defense.  The water damage from the busted pipe, in Mt. Hawley's view, caused only part of the damage, and the insurer refused to pay for repair of the part that it thought was already damaged from earlier leaks or just wear and tear.  This is just a guess, but the timing of Mt. Hawley's motion is interesting.

Mt. Hawley filed its motion to compel appraisal on July 15, 2009.  On July 3, 2009, the Texas Supreme Court issued its decision in State Farm Lloyds v. Johnson, #06-1071 (Tex. 2009) (see my discussion, Johnson Decision), holding that in certain situations, like the illustration described above, appraisers may decide causation issues before litigation in order to realize the cost-saving benefits of the appraisal process.  Mt. Hawley argued that it could not have anticipated that the Johnson decision would permit appraisers to resolve causation.

The court, however, agreed with Summit that the insurer waived its right to appraisal by litigating the dispute for a year.  The Johnson court based its decision in part on the cost benefits of appraisal before litigation, which is considerably more expensive.  Once the cost-saving is lost, and the issues are before the court in litigation, it is too late for appraisal.

As I stated in my discussion of Johnson, appraisal usually benefits the insurer, particularly when homeowners are seeking coverage.  Insurers are more familiar with the process and have appraisers they have used in the part.  We can expect to see insurers invoke the process more frequently.  They can't do so, however, if litigation is underway.

Retired Supreme Court Justice Dissents From 5th Circuit Majority's "Cramped" Interpretation of Policy

Certain Underwriters at Lloyds London v. Law, # 08-20159 (5th Cir. June 2, 2009) 

Sandra Day O'Connor magnanimously offered to help reduce the case backlog before the 5th Circuit Court of Appeals and sat by designation to review this lower court judgment in favor of the policyholder.  Thieves climbed onto the roof of a commercial building in Houston, broke open panels to the air conditioning housing, and stole copper coils from inside the units. 

The insured owner had insurance that excluded damage caused by theft, "except for building damage caused by the breaking in or exiting of burglars."  The term "building" is defined to include "fixtures, including outdoor fixtures," which everyone agreed would include these air conditioning units.  Nevertheless, the insurer denied the claim arguing that these thieves were not "burglars" breaking into or exiting the "building."

The lower court ruled in favor of coverage.  On appeal, the three-judge panel reversed this judgment and rendered that the policyholder take nothing, with Justice O'Connor (Ret.) dissenting.  Justice O'Connor found that Texas law required a little more insured-friendly interpretation than that adopted by the majority.  She reasoned that the air conditioners, as outdoor fixtures, were part of the building, and the burglars went into and exited the air conditioner housing panels.  A simple case based on the plain language of the policy.

However, the majority disagreed, "with the utmost respect," and held that "breaking in" to a building "unambigously contemplates nothing more expansive that an attempt to enter bodily into the interior space of the building as bounded by walls, floors, and ceilings."  Any other interpretation, said the majority, was "tortured."  

"But," Justice O'Connor (Ret.) admonishes, "nothing in the policy demands such a cramped understanding of intrusion to apply only to a building's 'inner space.' "  Texas law urges a more liberal reading in favor of policyholders than this.

I believe some of our courts could benefit from this instruction from the Honorable Associate Justice (Ret.), and I hope she will not give up on us in Texas.

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.

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.

Louisiana Supreme Court Agrees that "Flood" Exclusion Is Not Ambiguous

Sher v. Lafayette Ins. Co., No. 07-C-2441 (La. April 8, 2008), See Sher Decision.

"Flood" means flood.  In the latest in a string of defeats for Katrina property owners in New Orleans over the interpretation of the standard flood exclusion in property insurance policies, the Louisiana high court agreed with the Federal Fifth Circuit Court of Appeals in rejecting the interpretation that the exclusion does not apply to floods caused by levee failures due to negligent design.  (See In re Katrina Canal Breaches Litigation, 495 F.3d 191, 214 (5th Cir. 2007). 

Joseph Sher, owner and resident of a 5-unit apartment building, sought property and lost income coverage in the excess of $550,000 after Katrina flood waters had inundated the first floor of his building.  The insurer asserted that most of the damage was caused by poor maintenance and flooding that were excluded under the policy.  Specifically, the exclusion bars coverage for loss caused by "flood, surface water, waves, tides, tidal waves, overflow of any body of water, or their spray, all whether driven by wind or not."

The insurer offered to pay less than $3,000.  A trial court awarded Sher over $300,000, but the insurer appealed.  Insurer lost and appealed again.  The Supreme Court reversed.  On the key issue of the interpretation of the flood exclusion, the Court held that the term was capable of only one reasonable interpretation.

The plain, ordinary and generally prevailing meaning of the word "flood" is the overflow of a body of water causing a large amount of water to cover an area that is usually dry.  This definition does not depend on locality, culture, or even national origin - the entire English speaking world recognizes that a flood is the overflow of a body of water causing a large amount of water to cover an area that is usually dry.

This definition, the Court continued, does not distinguish between man-made and natural floods.  Therefore, the term is not ambiguous.  Moreover, the Court observed that even if such a distinction was supportable, no one could reasonably argue that Katrina flooding was not the result of a natural disaster.

For large commercial policyholders, alternative coverage should be available in, say, named-storm coverage.  Private homeowners probably have no alternative to the government-backed flood insurance program which has its own pitfalls. (see, for example, my discussion in Normal Legal Principles May Not Apply with Government Backed Insurance Program).  And here we are again at the beginning of another hurricane season.

New York High Court Allows Consequential Damages For Breach of Contract

Bi-Economy, Inc. v. Harleysville Ins. Co. (N.Y. Feb. 19, 2008) (see Bi-Economy Decision)

The highest court of New York has joined a number of other states that have allowed policyholders to recover consequential damages in excess of the policy limits for a first-party insurer's breach of contract.  "Consequential damages" are those that flow naturally and foreseeably from a breach but are beyond the direct damages that the parties actually contemplated, or probably contemplated, when the the contract was made. 

The seminal case illustrating the distinction between ordinary damages and consequential damages is Hadley v. Baxendale (England 1854) in which H., a mill owner, contracted with B., a carrier (we would say trucker today) to transport a broken mill wheel to engineers for repair by a specified date.  B. failed to deliver the wheel on time, and H sued for damages, including the lost profits for the extra time he lost while the mill was shut down.  B. protested that he was never told that H needed the wheel to keep his mill running, and the damages should be limited to those that were generally foreseeable by the parties at the time of contract.  The court agreed with B that a common carrier was not in a position to appreciate the likely effect of a shipping delay of cargo.  Nevertheless, the principle stuck that the party breaching its contract may be liable for indirect or consequential damages, such as lost profits caused by the breach, if the parties could have reasonably foreseen the consequences had they thought about it.

In this case, a meat market sustained inventory and structural damage from a fire.  The company was insured by a policy that covered loss form fire, including "business interruption," a common type of coverage for lost profits over defined period of interruption caused by the insured peril.  The period of interruption in this policy ended with the repair or replacement of the property, but no more than 12 months.  As often happens, the insurer and policyholder disagreed over valuation issues.  The insurer offered much less for the loss than the insured claimed and agreed to pay no more than 7 months of interruption, even though the company never returned to operation.

The dispute was submitted to alternate dispute resolution.  After more than a year, the insured was awarded more than twice what was offered.  The policyholder then sued for breach of contract and bad faith, alleging that the insurer improperly delayed payment for the direct loss and the full amount of its lost profits, and seeking consequential damages for the complete demise of the business, an amount in excess of the policy limits.  The insurer argued that, in addition to other defenses, the policy itself contained several exclusions of "consequential damages."  The lower courts granted the insurer's motion for summary judgment.

The New York Court of Appeals reversed and held that the insured's loss of its business was a foreseeable and probable result of the insurer's refusal to timely pay to restore the property and the lost income.  The dissent argued that the majority was confusing consequential damages with punitive damages.  The majority responded that consequential damages are designed to compensate a party for reasonably foreseeable damages, and so must be measured by actual loss.  Punitive damages, by contrast, are designed to punish or serve as an example and need not bear a close relation to the plaintiff's actual loss.  At any rate, the Court held that limiting an insured to the amount of the policy, "money which should have been paid by the insurer in the first place, plus interest, does not place the insured in the position it would have been had the contract been performed."

A few other states have awarded consequential damages as a bad-faith remedy.  See Lawton v. Great Southwest Fire Ins. Co., 392 A.2d 576 (N.H. 1978) (Allowing only policy limits plus interest would not make policyholders whole or discourage insurers from delaying a reasonable settlement); Beck v. Farmers Ins. Exch., 701 P.2d 795 (Utah 1985)(compensatory damages under policy may exceed policy limits and include damages for economic loss and mental anguish when those damages are reasonably foreseeable).

I am unaware of any Texas case that has awarded consequential damages in excess of the policy limits.  Texas does provide an 18% per annum statutory penalty for delay of payment of a first-party claim (Tex. Ins. Code Sec. 542.051).

Additional-Insured May Not Access Liability Policy Proceeds For Its Own Damages, Court Finds

Ohio Cas. Ins. Co. v. Time Warner Entertainment Co., # 05-06-01437 (Tex. App.--Dallas, Feb. 6, 2008) Court Opinion

After a string of policyholder victories in the Texas Supreme Court (see Texas Supreme Court About Face), Time Warner appears to be testing the waters with this case.  Time Warner (TW) hired a contractor to install fiber-optic cable around the City of Plano.  In addition to requiring the contractor to carry specified types and amounts of liability insurance, TW's contract also required it to be added as an additional insured to the contractor's CGL policy, a very common arrangement.  TW later sued the sub for negligently causing damage to the work and surrounding property.  Again, not an uncommon development.

TW then sued the contractor's CGL carrier seeking $1.5 million for property damages.  The trial court, for reasons not explained in the decision, granted summary judgment to TW.  On appeal, the court readily agreed with the insurer that TW, as the tort plaintiff, had no right to bring a direct action against the defendant's CGL insurer until it obtained a judgment or a settlement agreed to by the insurer.  Texas, unlike Louisiana, is not a "direct action" state.  Plaintiffs may not skip over defendants and directly sue their liability insurers.

TW then boldly demanded coverage for its damages by virtue of its status as an addition insured under the policy, relying on the recent Lamar Homes decision (see Lamar Homes Decision, holding that defective workmanship may constitute a covered occurrence and cause property damage under a CGL policy -- not a contested issue in the TW suit). 

To its credit, the court patiently analyzed the policy language and concluded that TW could not show any claim alleging TW's legal liability for covered damages.  Quoting Allan Windt's respected treatise, Insurance Claims & Disputes, the court observed, "Third-party liability policies require, as a condition precedent to the insurer's liability, that the insured be liable to a third person, by means of either a judgment or a settlement."

What was TW thinking?  Additional-insured status does not convert a third-party liability policy into a first-party property policy or a construction bond.  However, the court refused to render judgment in favor of the insurer and instead remanded the case to the trial court because the insurance claims were not ripe.  In other words, TW might be sued by Plano or adjacent landowners and so might be entitled to liability coverage at that time.  An adverse judgment now might unfairly impair TW's rights to such coverage.

Coverage Upheld For Other's Property In Insured's Control

Lone Star Heat Treating Co. v. Liberty Mut. Fire Ins. Co., 233 S.W.3d 524 (Tex. App.-- Houston [14th Dist.] 2007, no pet.)

This case concerns a dispute over a seldom-used provision found in many commercial general liability policies that cover the insured’s liability for the personal property of others in the insured’s care, custody or control.  The legal issue is whether this coverage was excluded under a fairly standard provision, the “dishonesty exclusion.”  In order to resolve this issue, the appellate court takes a rather lengthy, yet probably necessary, tour through the brambles of agency law.  Here, again, is an example of judges taking pains to get it right.

 

The insured engaged in the business of heat treating metals.  Customers typically shipped metal products to Lone Star for treatment and, after treatment, picked them up during business hours.  In this case, a person arrived at the loading dock after normal hours and pointed to two pallets of treated steel that he was purportedly sent to retrieve.  In this circumstance, the employee on duty was supposed to call the shipping supervisor, a man named Bierman, to confirm the pick up.  Instead, the employee said he could not release the pallets without proper documentation.  The “customer,” who identified himself as “Robert Smith,” said that Bierman knew about the pick-up arrangement but agreed to fill out a ticket for the product, which the employee accepted.  In fact, pallets belonged to different customers, and the steel was never recovered.

 

Lone Star’s general liability policy covered its liability to owners of property in the named insured’s possession.  However, the insurer denied the claim for $78,723.85 based on an exclusion of any loss “caused directly or indirectly by … dishonesty or criminal acts by you, any of your … employees … or anyone to whom you entrust the property for any purposes: (1) acting alone or with others; …”  In an ensuing coverage lawsuit, the trial court agreed with Liberty Mutual that the loss was excluded because it was caused by the dishonesty of Robert Smith to whom Lone Star entrusted the property.

 

Not so fast, Lone Star argued on appeal. “You” is defined in the policy as the Named Insured, not the broader class of other insureds, like Lone Star’s employees.  Because an employee, not Lone Star itself, handed the pallets over to Smith, and the employee was not acting dishonestly, the exclusion shouldn’t apply.  Liberty Mutual countered this argument by pointing out that corporations necessarily act through their representatives.  Because the employee was acting within the course and scope of his employment, he was acting on behalf of Lone Star.  Thus, the exclusion should apply.

 

The court held that the policy clearly distinguished between “you” as named insured and other insureds and rejected any wholesale identification of the corporation and its employees.  “The pivotal question is whether Lone Star entrusted the property. . . .  Accordingly, our focus is on common law doctrines that pertain to the two-party relationship between employee and employer.”  The court determined that Lone Star did not entrust the property to Smith because (1) Lone Star had a defined procedure for authorizing after-hours pick-ups (the employee was supposed to call and get authority from the shipping supervisor); (2) Bierman was not called; and (3) the employee knew he was not otherwise authorized to release the product, and there was no evidence that Lone Star had taken any action that might lead the employee to believe he could deviate from his instructions.

 

Because Lone Star did not give actual authority to its employee to hand the product over to Smith, and the employee had no other instructions that might induce him to believe he could use his own judgment in the matter, the court held that the exclusion did not apply.  Had Liberty Mutual developed evidence that employees routinely acted without express authority, and Lone Star knew about such deviations but took no action to correct them, the outcome might have been different.  The lesson for policyholders is to have and follow reasonable procedures for handling business.  Failure to do so can have unexpected consequences, such as loss of insurance coverage.

Congress passes 7-Year Terrorism Risk Insurance Extension

On December 18, 2007, the House passed the more modest Senate-approved version of the bill to extend the federally-backed insurance program called the Terrorism Risk Insurance Revision and Extension Act of 2007 (TRIREA).  A good description of the changes to this legislation can be found at CRS Summary of TRIREA.  The key features of the bill are:

• extends the program for 7 years
• federal participation begins at $100 million per incident loss
• applies to domestic as well as foreign acts of terrorism
• requires ongoing reports to Congress on inclusion of coverage for group life and nuclear, biological, chemical and radiological (NBCR) events
• caps federal participation at aggregate $100 billion

The White House has opposed federal participation in the program but is expected to sign this compromise extension.

Liberty Mutual Expands CGL Coverages For Specific Industries

Aimed at middle-market general liability (“CGL”) customers, Liberty Mutual Group announced 11 automatic coverages designed to address such common gaps as unintentional failure to disclose, mental anguish, coverage for health care professionals,, and coverage for injuries to co-employees resulting from Good Samaritan acts.  See New Coverages for fuller announcement.

Named Liberty Direct Solutions(TM), Liberty Mutual’s new “expanded” property and casualty products are targeted for select industries, including:

• Contractors

• Manufacturers

• Fabricated Metals Manufacturers

• Wholesale Distributors

• Retailers

• Food Processors

• Restaurant Owners

• Real Estate and Commercial Property Managers

• Professional Service Providers and

• Janitorial Service Providers

As the property/casualty market softens, competition increases for new business.  Whether these expanded products prove worth while to policyholders, of course, remains to be seen.  Still, I take this as a hopeful sign of a healthy market.