Law and Insurance

Second Circuit Finds "Insured-vs-Insured" Exclusion Ambiguous

Macey, et al. v. Carolina Casualty Ins. Co., No. 08-6067 (2d Cir. June 30, 2010), see Decision

This decision from the U.S Court of Appeals for the Second Circuit created an immediate buzz in the Directors-and-Officers insurance world because the court held that the so-called "insured-vs-insured" exclusion was ambiguous, always a terrifying word for insurers.  D&O insurance protects officers and directors against lawsuits alleging a wide assortment of wrongful acts while in office, usually shareholder actions in response to a stock plunge.  Excluded from coverage, however, are claims brought by one D or O against another.  Insurers are not keen to fund inter-corporate squabbles or revenge suits brought by a former director against the scoundrels that threw her out of office.  If courts strike down the insured-vs-insured exclusion as ambiguous, insurers might have to cover a whole lot more lawsuits.

But insurers take heart.  The Macey case probably does not portend the demise of the insured-vs-insured exclusion due to the unsual facts uderlying the decision.  In fact, the court did not actually say that the exclusion was ambiguous.  It remanded the case to the lower court to determine if the plaintiffs in the underlying lawsuit were in fact directors of the insured corporation.  In other words, the court held that the exclusion might or might not apply, depending on whether the insured corporation existed when the plaintiffs were directors.  The facts, you see, are complicated.

An Illinois corporation, call it CRA-Illinois, reorganized in May 2004 and merged with an investment company.  It emerged as a Delaware corporation, CRA-Delaware, later that year with new majority ownership.  The directors of CRA-Illinois became minority shareholders (named "Legacy Shareholders") and also became directors of CRA-Delaware but, according to the Share Purchase Agreement, only for the purpose of signing the paperwork necessary to complete the reorganization.  The Agreement also required that two of the three Legacy Shareholders resign from the board in order to close the merger.  The Agreement named as new directors three other inviduals (Macey et al.), who were later sued by the Legacy Shareholders.

After the merger, the company applied for D&O insurance, making the following representation:

On May 3, 2004, the company had a merger with an investment entity.  A new Chariman and Chief Executive Officer was installed.  The prior ownership remained in a minority capacity but were no longer participants on the Board or officers of the corporation.  On August 2, 2004 a Chief Financial Officer was hired.

The policy that issued incorporated the application as part of the insuring agreement, arguably becoming a stipulation of facts in the policy.  A year later, CRA-Delaware effected yet another merger, which pushed the Legacy Shareholders out completely, whereupon they sued the new directors.  The defendants sought coverage, which the insurer denied based on the insured-vs-insured exclusion.  The coverage action followed.

The lower court agreed with the insurer that the plaintiffs were former directors of CRA-Delaware, however slight their tenure may have been, and applied the exclusion.  On appeal, however, the court said that the lower court had not looked at the record closely enough.  Applying Virginia law to interpret the policy, the Second Circuit noted that an insurance provision is ambiguous if it is reasonably capable of two different intepretations.  The court continued:

The parties' opposing arguments are both reasonable interpretations of when CRA-Delaware came into existence.  On the one hand, [Macey, et al.] argue that CRA-Delaware came into being only at closing when it merged with CRA-Illinois, which occurred at the same time [the Legacy Shareholders] resigned, an interpretation that is captured in the [application].  On the other hand, Carolina argues that CRA-Delaware came into being at some point before the execution of all the documents and issuance of stock, and thus the Legacy Shareholders rightly fall within the "insured vs. insured" exclusionary clause.  Both of these interpretations rely on the language of the Policy and are reasonable in light of the various provisions of the Policy.

The court held that the exclusion appeared to be capable of two reasonable interpretations and remanded the case to the lower court to determine if the Legacy Shareholders should be considered "insureds" under the policy.  So why is this ruling not the death-knell of the insured-vs.-insured exclusion, at least in the Second Circuit, given that most courts will interpret an ambiguous policy in favor of coverage?

The court noted that there are two kinds of ambiguity: (1) when the provision is ambiguous on its face, called patent ambiguity, and (2) when the contract, though clear when written, "because of subsequently discovered or developed facts, may reasonably be interpreted in either of two ways," or latent ambiguity.  Although the court does not explicitly say so, this is probably a case of latent ambiguity, which should not have much persuasive effect on future court decisions.  The facts of this case are not likely to be repeated, particularly a representation in the policy itself that some individuals are not directors.  A finding of patent ambiguity might start the ball rolling in other courts.  Latent ambiguity may be a harder sale for policyholders.

Nonetheless, we may expect directors and officers to use the Macey decision to bolster an argument that the exclusion is ambiguous.  The insured need only persuade a court that it has a reasonable interpretation favoring coverage, and finding reasonable arguments is what lawyers do.

David S. White, Thompson & Knight LLP

www.tklaw.com

Court Finds Patent Infringement A Covered Advertising Injury

Hyundai Motor America v. National Union Fire Ins. Co. of Pittsburgh, No. 08-56527 (9th Cir. April 5, 2010) see Decision

This decision is a reminder of the potentially enormous value to businesses ensnared in intellectual-property litigation of an often-overlooked provision in just about every commercial general liability (CGL) policy, covering advertising injury.  This case is particularly remarkable because the court found that a patent-infringement allegation triggered the insurer's duty to defend, which almost never happens.  But even in copyright, trademark, trade dress, and other disputes over intellectual property that more readily trigger advertising-injury coverage, defendant companies often fail to check their CGL policies to see if their insurer might owe them at least a defense.  These type of cases usually cost millions to defend because the company's life blood may be at stake.  So, if your company is sued, check your CGL policy for the following:

Advertising Injury.  We are used to thinking of CGL policies covering bodily injury and physical damage to property, but standard policies also cover an odd assortment of offenses such as false imprisonment, invasion of privacy, wrongful eviction, malicious prosecution (my favorite), and advertising-injury offenses.  The insuring agreement is simple:  "[This insurance applies to:] "advertising injury caused by an offense committed in the course of advertising your goods, products or services . . .   "Advertising injury" is defined in this case as any of the following offenses:

1. Oral or written publication of material that slanders or libels a person or organization or disparages a person's or organizations goods, products, or services;
2. Oral or written publication of material that violates a person's right of privacy;
3. Misappropriation of advertising ideas or style of doing business; or
4. Infringement of copyright, title, or slogan.

The last two on the list are particularly apt in copyright, trademark, and trade dress litigation.

Two caveats: (1) the alleged injury must occur in the course of advertising, and (more tricky) (2) many jurisdictions, including Texas, also require that cause of the injury must be the advertising activity itself, not something else, such as the sale of the product being advertised.  Patent infringement usually fails this test because the injury is typically the sale of the infringing product, not the advertising.  This brings us to the Hyundai case.

Hyundai's Patent Infringement.  Hyundai, like most major corporations, maintains a website which  allows users to "build your own" (BYO) vehicle by navigating a series of menus of different colors, engine types, transmission types, and other options.  A customer may use a similar BYO feature to select customized parts.  A company called Orion IP, LLC holds patents for a "method of generating customized product proposals for potential customers of an automobile product."  Orion sued, alleging that Hyundai's BYO features infringed Orion's patents.  Hyundai sought a defense under its CGL policy, arguing that Orion alleged "misappropriation of advertising ideas."  The insurer denied the claim.  A jury found against Hyundai and awarded $34 million to Orion.  Hyundai then sued its insurer, seeking reimbursement of its defense costs but not the amount of the jury verdict.  (Not sure why Hyundai did not also seek coverage for damages, but advertising injury is often the tail wagging the dog -- only a tiny part of the lawsuit alleges advertising injury, which is enough to snag a defense but no more).

The coverage case was decided under California law, but the result would probably be the same in Texas and other jurisdictions.  The court first defined "advertising" as "widespread promotional activities directed to the public at large," which did not, however, encompass "solicitation."  The insurer had argued that use of a website entailed one-on-one solicitation, not advertising.  The court disagreed.  "A website is plainly directed to the public at large; therefore, the BYO feature constitutes 'advertising.'"

Misappropriation of Adverting Ideas.  The insurer next attempted to distinguish between the advertisement and the patented product and argued that the alleged injury concerned the patented product being advertised rather than the content of the advertisement.   The court again rejected the insurer's position.  Noting that patent infringement can qualify as an advertising injury if the patent involves "any process or invention which could reasonably be considered an advertising idea."  Here, said the court, "Orion patented a method of displaying information to the public at large for the purpose of facilitating sales."  In other words, Hyundai was using an advertising technique that was itself patented.  Thus, the infringement suit alleged an advertising injury.

Patent infringement fails to trigger coverage in most cases because the plaintiff complains that the defendant infringed the patent by manufacturing, advertising, and selling the patented product.  Courts routinely hold that the mere allegation that the product was advertised does not trigger coverage, because the advertising activity is not what caused the injury.  Sale of the patented product is the infringing activity.  That is why patent infringement is rarely covered.

However, insureds usually have a fair chance of receiving a defense in lawsuits in which the advertising, not the sale, caused the injury.  For example, if I infringe your copyright by advertising my product or service, and the advertisement includes material you copyrighted, the lawsuit should trigger the duty to defend because copyright infringement is an enumerated offense and the injury cannot be separated from the advertisement.  Even easier to cover are allegations over usurping trade dress or style of doing business in the course of advertising.  

Keep on your litigation check list: Is advertising injury alleged?

David S. White

www.tklaw.com

Kansas Still Recognizes Robust Bad-Faith Law, a Thing of the Past in Texas

Roberts v. Printup, 595 F.3d 1181 (10th Cir. 2010), see Decision

This sweetheart-deal case, serving up the hapless insurance company Kansas-style, is a reminder of how the art of bad-faith litigation used to play out in the Lone Star state before Gandy and other decisions tamed the wild west in the early 90's.  I couldn't resist pausing a moment over this case, sweet to recall for those legal giants who used to terrify insurers (here's to you, Rusty), and no less sweet for insurers, knowing they can no longer be dished up cold in Texas.

This variation of the sweetheart deal goes like this:  personal auto policy covers mother and son with maximum liability limits of $25,000.   Son drives auto into a tree, severely injuring mother, a passenger.  Insurer is notified and logs the claim as, "one-car accident, insured at fault."  Mother later tells the adjuster that the brakes failed, and she didn't think her son was at fault.  Insurer pays the no-fault personal-injury-protection (PIP) limit of $4,500, which is nowhere close to paying for mother's medical and hospital bills.  Insurer suspends further investigation.

A little less than 2 years later, mother consulted an attorney because she had heard that the policy might pay more than $4,500.  She then sent a letter to insurer, explaining that she was up against the 2-year statute of limitations in 10 days, she had over $150,000 in medical bills, and she would agree not to sue her son if insurer would agree to pay the $25,000 limits within 10 days. 

Now, freeze the frame.  At this point, the insurance company had done nothing wrong.  It acted promptly on the PIP claim.  The only claimant in the case, the mother, had stated that she didn't think her son was a fault, and liability was a condition for payment of the $25,000, which the mother did not claim until her demand letter.  So what did the insurer do? 

Insurer marked her letter "received" 8 days before the deadline but mistakenly sent it to the PIP department in Missouri, which mailed it back to the Kansas City Claims Department, where it was received three weeks after initial delivery, more than 2 weeks after the 10-day deadline.  Basically, folks, that's it.  From that point on, the insurer tried every way possible to stuff the $25,000, plus any attorneys fees incurred, into mother's hands, short of sending it with a Candy-gram.

Mother sued her allegedly negligent son, whom insurer defended.  Nevertheless, mother and son signed a settlement agreement (this is the sweetheart deal) in which son confessed judgment for $732,200 economic loss (past and future lost income), $250,000 for non-economic loss (probably pain and suffering), and $51,691.60 in medical expenses.  The agreement also proclaimed, "the settlement provided herein is fair and reasonable, is not collusive, and is entered into in good faith and as a means of amicably resolving their dispute."  The court entered judgment accordingly, and insurer, again, tried to tender the $25,000 limit.

Son then assigned his bad-faith claim to mother in return for an agreement not to execute the judgment (this is the second part of the bad-faith set up, formerly called the Texas two-step).  Insurer argued valiantly that its sin was only venial.  It missed the deadline by only a few days because of an inadvertent slip in the mailing room.  The lower court took pity on the insurer and dismissed the case, but not so on appeal to the 8th Circuit.

After reviewing Kansas bad-faith law, the court found:

It is readily apparent that it was foreseeable to [insurer] that its negligence in failing to implement a system to handle reasonable time-sensitive settlement offers from an injured party could result in a lawsuit being filed against its insured.  Accordingly, its attempt to accept the expired offer in this case did not absolve it of liability for damages to its insured caused by its earlier negligent failure to settle.

The court also found that mom's 10-day deadline was not arbitrary, but was justified given the impending statute of limitations.  (Reading between the lines, the court found no basis in the record for doubting the mother's story that she didn't find out that she might have a claim for the liability limits until shortly before the 2 years were up).  One can only imagine the firestorm that followed in the insurer's mail room.

That type of claim went the way of the cattle drive when the Texas Supreme Court ruled in State Farm Fire and Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996) that a prejudgment assignment of the insured's claim was against public policy.  Four years earlier, the same court killed the sweetheart deal in Elbaor v. Smith, 845 S.W.2d 240 (Tex. 1992), forbidding a defendant from agreeing to testify against another defendant in return for a % in the plaintiff's recovery.

Nowadays, for good or ill, a plaintiff can only rarely survive an appeal of a bad-faith verdict against an insurer. 

Judge Finds Policy Ambiguous But Rules Against Coverage. How Can That Be?

Jefferson Block 24 Oil & Gas, LLC v. Aspen Ins. UK Ltd, No. 08-cv-4792-JCZ-SS (E.D. La. Jan. 29, 2010) see Jefferson Block Decision

Every time I see a politically contentious senate confirmation hearing over the appointment of a judge to the federal bench, I am reminded of how seldom political philosophy or partisanship has anything to do with resolving actual cases and controversies, and, how hard good judges work to reach the legally correct result.  Facing the judge in this case are a host of perplexities, including out-of-state law (the policy selected New York law), a set of federal laws and regulations requiring insurance coverage for certain offshore pollution risks, and common law rules of interpretation over ambiguities, extrinsic evidence, and the policyholder's reasonable expectations.   On a very close call, the judge ended up ruling in favor of the insurers, but only after a careful and astute review of the facts.

The policyholder, Jefferson Block ("JB"), specialized in acquiring and reworking abandoned offshore oil and gas leases.  A federal law known as the Oil Pollution Act ("OPA") requires "responsible parties" to purchase clean-up insurance for any lease or "facility" (which includes pipelines) with a worst-case spill risk of more than 1,000 barrels.  JB acquired a $10 million OPA policy covering two leases and "facilities" in the Gulf of Mexico.  One of the pipelines leading from a covered lease leaked costing $3 million for the cleanup.

The insurers refused to reimburse JB arguing that the pipeline itself was not within the lease and was not otherwise scheduled in the policy.  Here is where it gets complicated.

The schedule refers to certain forms prescribed by an agency of the Interior Department that JB fills out and submits to the agency and the insurer.  One part of one of the forms allows JB to choose either a "General" or "Schedule" Option.  The General Option would cover all areas and facilities for which the insured could be held liable for cleanup under the Act.  Alas, JB chose the Schedule Option and failed to list the leaky pipeline.  But that doesn't end the inquiry because nothing in the form or the Act requires listing out-of-lease pipelines.  Being a federal regulation under a federal law, the matter appears hopelessly garbled.  The court, therefore, decided that the policy application and schedule were ambiguous.

At this point JB probably celebrated because usually ambiguities are resolved in favor of the insured.  That, however, is not exactly how the principle works.  When the contract is susceptible to two or more reasonable interpretations, the court must try to determine the parties' intent.  If extrinsic evidence (evidence outside the contract itself) establishes the parties' intent, then the court may consider that evidence even if it favors a decision in favor of the insurer.

It seems that JB hired a consulting firm to assist in the regulatory side of the insurance coverage.  Communications between JB and the consuting firm indicated that JB understood that the off-lease portions of the pipelines needed to be listed separately on the schedule.  The correspondence also tended to show that JB understood that the OPA didn't require coverage for the off-lease pipelines and that JB's intent was to obtain only as much coverage as required.

But here's the kicker in the court's view.  An email from a consultant helping prepare the agency form advised that he had shortened the application to show only two lines for the express reason that each additional line (required to list each pipeline) would generate more premium.  From all of the evidence, therefore, the court concluded that JB intentionally applied for more restricted coverage that did not cover the pipeline in question.  Since JB was the drafter of the application form that was ambiguous, the judge, in effect, reversed the usual rule that ambiguous provisions favor coverage.

The decision is worth a read to appreciate the court's careful, unbiased evaluation.  I have not mentioned some of the rabbit trails the insurer tried to run, dodges that the court examined and rejected.  In the end, this case presents a close call.  Some of the extrinsic evidence tilts against the insurer.  But the court deserves a round of applause for its effort, which upholds the best traditions of the American judiciary.

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