Law and Insurance

Connecticut AG Announces $1.3 MM Hartford Settlement of Price-Fixing Conspiracy

Two novel developments this week.  First, the House Judiciary Committee approved H.R. 3596, a bill that would remove the antitrust exemption in the McCarran-Ferguson Act of 1945 for health and medical malpractice insurers.  See Health Insurance Industry Antitrust Enforcement Act of 2009.  The Senate Judiciary Committee is considering the same legislation in S. 1691.  Although the politics and emotions roused in the the debate over this legislation is seen as just another wrinkle in the health care reform debate, repeal of McCarran-Feguson has been kicked around for years.  Proponents of the bill argue that the insurance industry, particularly health insurance, is not competitive, in part because insurers have managed under lax state controls to conspire, fix prices, and carve up markets.

Not so, says the Attorney General of Connecticut, Richard Blumenthal, who yesterday announced a $1.3 MM settlement with Hartford Financial Services Group, the first antitrust settlement of its kind in the reinsurance industry.  See Press Release.  The settlement is part of ongoing litigation by Blumenthal against Guy Carpenter & Company LLC, one of the world's largest reinsurance brokers.  The Connecticut AG began the action in 2007 against Guy Carpenter and reinsurers, like Hartford, allegedly part of a market allocation and price-fixing conspiracy.  This action is similar to the other enforcement suits that spun out of Eliot Spitzer's 2006 New York investigation of Marsh McClennan and other brokers.

"The Hartford is making history by this first-in-the-nation settlement --- and drawing back the cloak of secrecy on a series of illegal price-fixing conspiracies that inflated insurance costs by hundreds of millions of dollars nationwide at the expense of 170 insurance companies and their customers," said Blumenthal.

Hartford, one of 20 alleged co-conspirators, cooperated in the investigation, said Blumenthal, hence the light penalty.  Blumenthal also commented:

"Bolstered by backroom deals, insurance industry inertia and an unregulated market, Guy Carpenter's conspiracies continued undetected for almost 50 years.  The Hartford helped Guy Carpenter create an illusion of competition, but now has helped my investigation to break apart business practices that have inflated costs for consumers by as much as 40%."

So which is more compelling, head-cracking, fire-breathing state regulators fully capable and financed to police the insurance industry state-by-state, or the fact that this type of arrangement went on for 50 years before anyone blew the whistle?  A spokesperson for the health insurance industry, Karen Ignagni, said in a letter to the chairman of the House committee that the bills are unnecessary because McCarran-Ferguson doesn't shield insurers from antitrust regulation.  See Repeal of Antitrust Exemption.  "The bills attempt to remedy a problem that does not exist," said Ignagni. 

I'd call that an overstatement.  The problem exists.  Which is the better remedy is the question.  If I had to bet, with or without health care reform, state regulation of insurance is probabaly on its way out.

Policyholder Dodges a Bullet On Late-Notice Quandary

SNL Financial, LC v. Philadelphia Indemnity Co., No. 3:09-cv-00010 (W.D. Va. September 30, 2009), see SNL Decision

This time the policyholder escaped the steel jaws of the late-notice trap.   But why do they linger like moths before the flame when prompt notice of what may or may not be a "claim" will avert any danger of losing coverage?

Claims-made policies are rampant now-a-days, particularly with errors & omissions, directors & officers, and professional liability policies.  Coverage under these policies is triggered not by the occurrence of the covered risk during the policy period, the alleged wrongful act itself, but by the claimant's assertion of the claim arising form the conduct.  The concept is simple:  should you, the insured, open your mail one day and find a "claim" being made against you, alarms should sound, and you immediately forward said claim to your insurer, who responds within 15 business days (in Texas) that receipt of claim is acknowledged within the policy period then in effect. 

The SNL case from Virginia illustrates that it is not always easy to recognize that the communication you received is a "claim." 

The policy at issue covered employment-related wrongful acts, such as discrimination, harassment, wrongful termination and the like.  The policy period was August 1, 2008 through August 1, 2009.  Philadelphia had issued employment-practice liability policies to SNL before and after the policy period in question.  But, the steely trap is that a claim made against SNL in one year that is submitted to Philadelphia the next year is not covered.

SNL received a letter on January 18, 2008 from an attorney stating a desire to meet with SNL's president to discuss "certain discriminatory conduct" against the attorney's client, a former SNL employee.  Numerous communications followed between the attorney and counsel for SNL, including a February 1, 2008 email, titled "Litigation Hold," instructing SNL to preserve all evidence that might be relevant to the former employee's potential claims.  In May 2008 SNL was permitted to review a draft complaint against SNL.  In July 2008, SNL's counsel asked the attorney if he wanted to make any demand for money to SNL, but the attorney declined.

Also in July, SNL submitted a renewal application to Philadelphia and marked the "no" box next to the question whether SNL "had been the subject or involved in any litigation in the past 12 months."

Suit was filed in October 2008, whereupon SNL submitted the matter to Philadelphia, who denied the claim due to late notice (as well as failing to truthfully disclose the claim in the application).  Coverage litigation ensured.  The court correctly identified the $64,000 question in the case.  "Had SNL received a "claim" before August 1, 2008?"

The policy defined "Claim" in several ways (mostly this or that type of formal proceeding or lawsuit), including, "a written demand for monetary or non-monetary relief."

The coverage quandary here for the policyholder reminds me of the Dirty Harry challenge.  I don't know how many of you are fond enough of Clint Eastwood to remember the climactic question in "Dirty Harry," during the gun-to-gun showdown when the bad guy is trying remember if Harry had shot all 6 rounds from his 357 Magnum, or just 5.  But, says Harry, since this is "the most powerful handgun in the world and would blow your head clean off, you've got to ask yourself one question: Do I feel lucky?  Well, do ya, punk?"

Is a "litigation hold" letter instructing SNL to preserve documents relevant to potential claims a demand for non-monetary relief?  You got to ask yourself.

Here the judge found that no claim had been submitted.  The monetary or non-monetary relief was either not presented in a written request or was not unequivocally demanded.  Luck goes to the policyholder.  I have appeared before plenty of judges who would have poured out the policyholder for being so dumb as to sit on letters like these instead of turn them over immediately.

The kicker is that most policies of this sort, including this one, have a mercy provision that allows the insured to send in communications that may or may not be "claims" but clearly point to potential claims, and nail down coverage later down the road, in a year or two, when the lawsuit is actually filed.  The policy in effect when notice of the potential claim is sent will cover the lawsuit.

So what excuse does the policyholder have for not promptly sending in hostile letters from attorneys or ex-employees? 

South Carolina Supreme Court Affirms Bad Faith Punitive Damage Award

Correction: Court calculated actual damages at $1,081,189.40.

Mitchell V. Fortis Insurance Company, # 26718 (S.C. September 14, 2009), see Mitchell Decision

This decision out of the South Carolina Supreme Court is remarkable first as a model for intelligent, careful consideration of a difficult legal and factual issue, and second, I have not seen such outrageous conduct by an insurance company since the wild and wooly days before bad faith liability entered American jurisprudence (yes, I am that old). 

Briefly the facts:  Mitchell, 17, applied for health insurance when he left home and went away to school.  The insurance application asked if he had even been diagnosed or treated for any immune deficiency disorder.  He answered no and submitted the application to Fortis on May 15, 2001.  In April 2002, Mitchell's blood was screened by Red Cross and tested positive for HIV.  On May 14, 2002, Mitchell contacted a doctor who confirmed the result and noted in a medical chart that Mitchell tested positive for HIV, was 18 years old, and the date of the confirming test was May 14, 2001 (not 2002). 

Mitchell submitted insurance claims for the tests and subsequent treatment.  Fortis investigated, found the referral note with the erroneous date, and concluded that Mitchell had lied on his May 15, 2001application.  Fortis rescinded the policy and refused payment.  There followed a series of communications to Fortis from Mitchell, his doctor, his lawyer, and his mother's insurance agent, all providing ample proof that Mitchell's first inkling that he was HIV-positive was in 2002 and urging, even begging, that Fortis reconsider its decision. 

All calls to Fortis were routed to one or another customer service representative who invariably said that there "was nothing [the representative] could do."  The Fortis rescission committee that initially made the decision met to consider the appeal and noted only that Mitchell's lawyer had written that Mitchell had not lied because the diagnosis was first made a year after the inception of the policy.  Apparently finding lawyers inherently untrustworthy, the committee refused to budge.  Evidence developed later in the lawsuit showed that Fortis, contrary to its usual practice, either had failed to log telephone calls to its claims manager, or those logs were deleted.  Fortis also twice sent Mitchell altered or illegibile copies of the referral form that contained the wrong date. 

Folks, it gets worse.  At trial, Mitchell produced evidence that it was Fortis' practice to shut down an investigation once a single piece of evidence was discovered that would support rescission.  (Even in Texas, where bad faith is rarely sustained on appeal, this evidence would doom an insurer).  Then, a Fortis manager testified that she was not "able to answer" whether she or any of her employees "had a responsibility to find out the truth" about a policyholder's medical conditions.  Oy vey!

The jury awarded Mitchell $186,000 in compensatory damages, $36,000 on the breach of contract claim, and $15,000,000 in punitive damages.  Fortis appealed the punitive damages award as violative constitutional due process.  The South Carolina High Court got down to business.

Ever since the U.S. Supreme Court recognized due process restrictions on state-imposed punitive damages in BMW of North America v. Gore, 517, U.S. 599 (1996), the courts of the land have struggled to find reasonable criteria for evaluating the amount of punitive damages an incensed jury might award.  The Mitchell Court applied the three basic criteria stated in Gore: (1) the degree of reprehensibility of defendant’s conduct, (2) the disparity between the actual or potential harm and the amount of the punitive damages (ratio), and (3) comparative penalty awards from other cases.

The South Carolina High Court first found that actual damages should have been calculated at $1,081,189.40, but found that the award, almost 14 times actual damages, was excessive under the Gore criteria. Accordingly, the Court determined that an award of approximately 9 times actuals would not offend due process and would comport with South Carolina's "substantial history of upholding punitive damages wards against insurance companies that fraudulently rescind their customer’s heath insurance policies.”   Noting that without the coverage, Mitchell could not afford treatment and would lilkely die of AIDS within a few years, a fact of which Fortis was aware (in fact, Fortis reinstated the policy but only after getting kicked in the slats in court), the Court remitted the award to $10,000,000.

Because the pre-existing exclusion appears to be on everybody's health-care reform list, this case may be among the last of these enormities we will see.  Let's hope so.

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.

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.

Florida High Court Ponders Whether Unsolicited Fax Might Be a Covered "Advertising Injury"

Penzer v. Transportation Insurance Company, # 07-13827 (11th Cir. October 23, 2008), see Penzer Certified Question

Does an alleged violation of the Telephone Consumer Protection Act (TCPA) trigger a commercial general liability insurer's duty to defend an alleged "advertising injury" offense, defined in the policy as "publication of material that violates a person's right of privacy"?  In other words, does an unsolicited faxed advertisement violate a right of privacy, covered in the insurance policy, when the content of the fax is not itself offensive, but the mere transmission violates TCPA and entitles the recipient to a $500 per-fax penalty?

The federal Eleventh Circuit Court of Appeals, applying Florida law, could not answer this question and certified the issue to the Florida Supreme Court, which will probably agree to resolve the dispute.

The TCPA is a federal consumer protection statute designed to discourage faxing unsolicited advertisements by permitting the recipient to sue and recover actual damages or the $500 penalty.  I know attorneys who have set up phone banks in otherwise empty offices to milk unsolicited faxes and sue for $500 a pop.  One unfortunate company, American Blast Fax (ABF), offered to send thousands of single page advertisements for business customers believing that this would not violate the TCPA as long as the transmissions did not cross state lines.  Wrong.  Hundreds of thousands of faxes were blasted, and my lawyer friends' milking machines lit up.

Most of the companies who were sued after believing ABF's assurances that the advertising was legal maintain CGL insurance policies that cover, in addition to bodily injury and property damage, certain specific offenses, including the advertising injury offense stated above.  The CGL insurers often deny coverage for TCPA claims arguing that the policy covers alleged violations of privacy only when the "material" or content of the fax was offensive.  The mere nuisance of receiving the fax is not a covered offense, say insurers, in the absence of offensive content.  The counterargument is that, as long as the "material" is "advertising," it falls within the terms of the policy and should trigger the insurer's duty to defend.

While Florida ponders this question, it is worth noting that Texas and a number of other states have sided with the policyholder on this issue.  In W. Rim Inv. Advisors, Inc. v. Gulf Ins. Co., 269 F. Supp.2d 386 (N.D. Tex. 2003), a Texas federal district court noted that most jurisdictions recognize four types of invasions of privacy: (1) intrusion upon seclusion; (2) public disclosure of embarrassing private facts; (3) publicity placing a person in a false light; and (4) misappropriation of one's name or likeness.  An unsolicited fax advertisement, without otherwise offensive conduct, might constitute an intrusion upon seclusion.

The insurer in Rim Inv. Advisors raised the same objection asserted by Transportation in the Penzer case, plus a few more.  Gulf argued that the a TCPA violation is not an advertising injury under the policy, which covers only common law invasion of privacy, not statutory consumer protection laws.  Second, without offensive content, a fax cannot be an invasion of privacy.  Third, the $500 per-fax penalty is not "damages" and so not covered.  And four, to be covered, an advertising injury requires "publication," meaning dissemination to one or more third parties.

Not so, said the court.  A TCPA violation can constitute an intrusion upon seclusion, which does not require publication to third parties.  The fax itself is adequate publication.  Also, mere receipt of the fax, regardless of content, may violate a person's seclusion right.  Finally, the TCPA allows the plaintiff to recover actual damages or the $500 penalty, which is not criminal and so may be characterized as "damages."

This is in accord with the view of most other jurisdictions.  So Florida waits.

Go Gators

Insurance Reserves Are Discoverable in Bad Faith Litigiation

Brothers Petroleum, LLC v. Underwriters at Lloyd's London, CA No. 06-2836, 2008 U.S. Dist LEXIS 51389 (E. D. La. July 2, 2008).

Whenever a claim is submitted to an insurance company for loss or liability, the insurer typically sets a reserve, an estimate of what the claim will cost the insurer.  Many states require insurers to set a reserve.  Of course, claimants would love to be able to discover the amount of reserve set, which,in a claim negotiation with the insurer, is the equivalent of looking at the other guy's poker hand.  Courts ordinarily do not allow discovery of reserve information, primarily because the reserve is simply the insurer's preliminary approximation of the amount of loss, not direct evidence of the damages.  Claimants do not ordinarily need to discover the insurer's reserve to prove up the loss.

This case illustrates a common exception allowed by courts.  When the insured, or another insurer standing in the insured's shoes, sues the insurer for denying or underpaying a claim in bad faith, the reserve may be considered relevant.  In the Brothers case, the policyholder submitted a claim for Katrina-related loss.  Lloyd's appears to have paid part of the claim, and after attempts to resolve the dispute, Brothers sued for additional damages and for bad faith delay under Louisiana law.  In the discovery process, Bothers asked for the insurer's files, including reserve information.

The court noted:

A bad faith claim requires an analysis of whether the failure to pay the amount of a claim within 60 days after receipt of a satisfactory proof of loss was arbitrary, capricious or without probable cause, as determined by the facts and circumstances held by the insurer at the time of refusal. (La. Rev. Stat. 22:1220).  The setting of reserves bears some relationship to the insurer's calculation of potential liability, and have [sic] been found to be discoverable when bad faith is asserted.

In other words, an insurer who refuses or delays in paying a $3 million claim and asserts that the damages are only $2 million, may be acting in bad faith if its own reserve is set at $4 million.  (I say "may be" because the insurer may have a good explanation for its early overestimation of loss.  For example, significant new evidence emerging after setting the reserves may justify a lower valuation come settlement time -- but no insurer wants to have to fight this fight).

Several other courts have taken the same approach and allowed discovery of the reserve when bad faith is alleged.  (See e.g., North River Ins. Co. v Greater New York Mut. Ins. Co., 872 F. Supp. 1411 (E.D. Pa. 1995)).  Courts will likely continue this trend.

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.

New Mexico Supreme Court Requires Insurers To Defend When They Have Actual Notice of a Suit; Not So in Texas

Garcia v. Underwriters at Lloyd's, London, Op. # 2008-NMSC-018 (N.M. March 13, 2008).  See Garcia Opinion.

Although Texas and New Mexico share a border, they appear to be on opposite poles of the insurance planet, at least on this issue.  The Supreme Court of New Mexico holds in the Garcia opinion that a liability insurer's duty to defend is presumptively triggered when it receives actual notice that a lawsuit has been filed against its insured, not, as under Texas law, when the insured forwards the suit papers and demands a defense.  To overcome the presumption that it must defend, the insurer has to prove that the insured turned down the insurer's offer of defense or was unresponsive or uncooperative.

The rule in Texas, recently reaffirmed by the Texas Supreme Court, is that an insurer is under no obligation to "gratuitously subject itself to liability" by offering to defend an insured who has not asked for a defense or forwarded suit papers to the insurer.  See National Union Fire Ins. Co. v. Crocker, 246 S.W.3d 603, 608 (Tex. 2008) (holding that additional insured was not entitled to a defense absent written demand on the insurer, even though the additional insured was unaware that his employer's policy would cover him as well and so did not request a defense, and the insurer was defending the co-defendant employer in the same lawsuit and knew the employee was covered and paying for his own defense).  See my discussion of the Crocker decision at Liability Insurer Has No Duty to Inform Additional Insured That Coverage Exists. 

The Crocker Court's rationale is that the policy typically states that the insured's actual demand and submission of the suit papers is a condition precedent in the policy, and the condition serves the essential purposes of (1) facilitating timely and effective defense and (2) triggering the duty to defend by notifying the insurer that a defense is expected.  If this rule seems somewhat overly protective of the insurer's interests, you are not alone.

The approach adopted in the Garcia decision is animated by the contrary policy of protecting the reasonable interests of insureds.  The facts in Garcia are a little messy, involving the vagaries of New Mexico probate process (indeed, the reason Lloyd's took no action to defend the insured's estate sued in a dram shop lawsuit was that its New York counsel misread New Mexico probate law and assumed the probate court had no jurisdiction over the tort action).  Moreover, the Court acknowledged that fact issues existed on whether the estate administrator adequately demanded a defense (apparently, the administrator also misunderstood New Mexico probate law and thought that he did not have the authority to demand a defense and instead urged Lloyd's to petition the probate court for the right to defend the estate -- at this point my teenage son would write "LOL").  In other words, the New Mexico Supreme Court did not have to make a new law.  It just wanted to.

The Garcia Court held that the burden of communicating about the defense should fall on the insurer.  The insurer knows, reasoned the Court, that most of the time insureds will want the benefit of a defense.

Why then should the insurer receive the benefit of a rule requiring written tender . . .?  Such a rule requires an insured to jump through meaningless hoops towards an absurd end: telling the insurer something it already knows.  Such a rule injects a degree of gamesmanship into the insurer-insured relationship without providing any valid corresponding benefit.  In fact, the only benefit of such a rule is to create a possibility--where none otherwise exists--for an insurer to escape an obligation it otherwise owes its insured.

(Quoting Federated Mut. Ins. Co. v. State Farm Auto. Ins. Co., 668 N.E.2d 627, 632-33 (Ill. App. Ct. 1996).

Nor does the insurer have to learn of the lawsuit from any particular source.  "We hold that, for the purposes of determining when an insurer's duty to defend arises, 'actual notice means notice from any source sufficient to permit the insurer to locate and defend the insured.'" (quoting Illinois Founders Ins. co. v. Barnett, 710 N.E.2d 28 (Ill. Ct. App. 1999)).  The Garcia Court found that a question of fact existed whether the administrator's letter constituted a rejection of a a defense (that was never offered) and sent the parties back down to the lower court for trial on this issue (at least there weren't sent into the jungle of New Mexico probate jurisdiction).

So which is the better approach?  The Garcia Court did not discuss the possibility that unscrupulous plaintiffs could collude with insureds to give the insurer just enough actual notice of the lawsuit to trigger the duty to defend and then obtain a monster default judgment before the insurer can find the insured and tender a defense.  Although this is possible, many jurisdictions, including Texas, have fairly forgiving procedures for overturning default judgments, particularly when the real party in interest, here, the insurer, has been unfairly excluded from participating. 

On balance, it is easier to picture instances of unfairness to the insured, as in Crocker, than to the insurer, particularly when the insured is unsophisticated and does not know of the available policy benefits.  Absolving the insurer of any obligations whatsoever unless the insured affirmatively demands a defense gives the insurer every incentive to keep mum even when the insurer knows that the insured is ignorant of its rights.  Additional insureds in commercial contexts often do not even know the identity of the insurer.  The rule adopted in Garcia seems less likely to lead to unfair results for either party and, when it does, is probably easier to fix through review procedures.

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.