Law and Insurance

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.

U.S. Supreme Court Rejects Contractual Expansion of Judicial Review of Arbitration Awards

Hall Street Assocs., L.L.C. v. Mattel, Inc., No. 06-989 (U.S., March 25, 2008) See Hall Street Decision

In a landmark decision, the United States Supreme Court held that the increasingly popular practice of contracting for expanded judicial review of arbitration awards is not permissible under the Federal Arbitration Act (the "FAA").  This practice was seen as a way to obtain the benefits of arbitration while eliminating one of its drawbacks: limited judicial review.  The Hall Street decision may have the unintended consequence of driving parties away from arbitration.  Since expanded judicial review is now much less available, more parties may opt for traditional litigation with its right to appeal a bad result.

For a fuller discussion of this decision, see Client Alert, published by Thompson & Knight Appellate Practice Specialty Group.

Bear Stearns Bungled Insurance Coverage Before Collapse

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

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

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

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

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

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

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

5th Circuit Rules Out Economic-Loss Doctrine in Failure To Procure Insurance Claim

SMI Owen Steel Co. v. Marsh USA Inc., No. 06-41387 (5th Cir. March 7, 2008) See SMI Opinion.

Last year, the Texas Supreme Court banished the "economic-loss doctrine" from any place in insurance coverage analysis.  See my discussion of the Lamar Homes Opinion.  In the SMI case, the 5th Circuit finds, under Nevada law, that an insured's negligence procurement claim against an insurance broker is not barred under the same doctrine.

In the last decade or so, the economic-loss doctrine has emerged as a powerful defense against any tort claim brought against a defendant in a contractual relationship with the plaintiff.  One court defined the doctrine this way:

Broadly speaking, the economic loss doctrine is designed to maintain a distinction between damage remedies for breach of contract and tort.  The term "economic loss" refers to damages that are solely monetary, as opposed to damages involving physical harm to person or property.  The economic loss doctrine provides that certain economic losses are properly remediable only in contract.  The doctrine has its roots in common law limitations on recovery of damages in negligence actions in the absence of physical harm to person or property.

Giles v. General Motors Accept. Corp., 494 F.3d 865, 873 (9th Cir. 2007).  "The primary purpose of the rule is to shield a defendant from unlimited liability for all of the economic consequences of a negligent act, particularly in a commercial or professional setting, and thus to keep the risk of liability reasonably calculable."  Local Joint Executive Bd. of Las Vegas v. Stern, 651 P.3d 30, 51 (Nev. 1982).  Pushed to its extreme, however, the rule would eliminate any extracontractual causes of action for legal malpractice or, in this case, a broker's negligent failure to procure insurance.

The facts of this case are complicated.  SMI was a subcontractor on a large construction project.  Marsh was the insurance broker procuring a variety of insurance policies for many of the contractors and subs in the project.  SMI was sued for negligent design and fabrication of its part of the project.  Marsh issued several certificates of insurance reflecting that SMI was covered for professional liability when in fact no such coverage was procured (whether Marsh was supposed to procure the coverage is a disputed point, but a jury found that it was but negligently failed to do so).  SMI settled the underlying lawsuit and sued Marsh on several theories.  A jury awarded SMI over $7 million for Marsh's negligence.

Marsh raised two defenses on appeal.  First, Marsh argued that the professional liability policy it would have procured would have excluded the claims against SMI, so Marsh's negligence did not cause any damage.  The court found that sufficient evidence existed to undermine that defense.  Marsh also argued that SMI could not recover under the negligence theory due to the economic-loss rule.  The court reviewed Nevada law and found that Nevada recognized a cause of action against an insurance agent for negligent failure to procure insurance.  Moreover, the court found that, although the Nevada Supreme Court had applied the economic-loss rule in some cases, none of these cases involved alleged violation of a professional, extracontractual duty imposed by law.

In other words, if the alleged violation constitutes a violation of a duty imposed by law, independent of the express duties undertaken in the parties' contract, then the doctrine will not apply.  The Nevada Supreme Court had held in an earlier case that insurance brokers are not obligated to assume the duty of procuring insurance, but when they do so, the law imposes upon them a duty of care to perform non-negligently.  Therefore, the SMI Court held that the economic-loss rule did not apply to failure-to-procure claims against insurance brokers.

And so the economic-loss doctrine loses a bit more of its swagger.

New York High Court Allows Consequential Damages For Breach of Contract

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

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

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

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

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

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

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

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

Federal Courts Reach Opposite Results Over Scope of Insured vs Insured Exclusion in D&O Policies

Home Federal Sav. & Loan Ass'n v. Federal Ins. Co., No. 06-CV-3053 (N.D. Ohio, September 14, 2007); 

 

Westechester Fire Ins. Co. v. Wallerich, No. 07-2145 (D. Minn., September 25, 2007)

 

These two Federal District Courts reached opposite results on whether an "insured vs. insured" (IvI) exclusion in a directors & officers (D&O) liability insurance policy excludes all coverage for the entire lawsuit when only one of several plaintiffs is an insured under the policy.  (As the name implies, the IvI excludes any “Claim” brought or maintained by any insured).  The Minnesota court held that because the policy defined “Claim” as “a civil proceeding . . .,” the exclusion should apply to the entire lawsuit, not just to the insured’s claim.

 

The Ohio court held that the exclusion applied only to the insured plaintiff's claim and allowed coverage for the claims asserted by the other plaintiffs, because the term “Claim” could refer to separate civil proceedings had each plaintiff filed its own lawsuit.  Therefore each plaintiff’s claim is separable.

 

Also, the Ohio court held that “Claim” may be ambiguous because the term is used elsewhere in the policy to refer to the allegations asserted, not the civil proceeding as a whole.  Specifically, the Ohio court looked at the policy’s defense-cost-allocation clause that pre-sets the percentage of total defense costs the insurer will pay when a lawsuit alleges both covered and uncovered “claims.”  Therefore, the insured’s Claim may be separated from the other Claims and excluded without excluding the other Claims.

 

Apparently, neither policyholder argued that the Claims should be separated because the definition of ”Claim” includes more than just “a civil proceeding, . . .”  Most D&O policies include “a written demand for monetary or non-monetary relief” as a “Claim.”  Accordingly, any case that was preceded by several demand letters, as often happens, began with several “Claims.”  Arguably, most courts would be reluctant to accept an interpretation of the term that allowed a different result depending on whether the demand letter or the civil action was used as the operative “Claim,” or whether the plaintiffs wrote separate demand letters. 

 

The Minnesota court may have reached its decision based on the fact that the plaintiffs were husband and wife, and the wife had nothing really to do with the company other than to receive assets in the marital estate.  In other words, the lion’s share of the “Claim” was against the insured husband.  In the Ohio case, by contrast, the insured plaintiff was one of many shareholders suing the company.

California Court Rescues CGL Coverage From the Jaws of Broad Auto Exclusion

Essex Insurance Company v. City of Bakersfield, 154 Cal. App. 4th 696 (Cal. App. 2007)

This case illustrates the court's use of California's "reasonable expectations" doctrine to restore a city's coverage under its commercial general liability (CGL) policy for liability arising the others' use of automobiles, despite a policy amendment that excluded liability arising from the use of any autos.  This case also serves as a useful illustration of, by way of deviation from, when CGL policies typically cover car accidents and when auto policies should apply.

In this case, the city was hosting an annual fundraising event and posted exit signs from the event that channeled departing traffic onto a state highway.  The driver of a tractor trailer swerved to avoid a departing vehicle resulting in a collision and injuries.  Lawsuit followed including allegations against the city for creating a dangerous condition that helped  cause the accident.  No city vehicles were involved, and none of the vehicles or divers involved were connected with the city.  City sought a defense from its CGL insurer, Essex, which denied coverage on the basis of an exclusion in the policy for bodily injury "arising out of the ownership, non-ownership, maintenance, use or entrustment to others of any auto."

In an insurance coverage action, the lower court applied the exclusion as written and granted judgment to the insurer.  Even though the allegation against the city did not involve the use of an auto, clearly the injuries "arose out of" the auto accidents.  Note that the city's commercial auto policy would not cover this kind of accident because it did not involve an "auto" owned, rented or used by the city.  So how did the City of Bakersfield manage to purchase a liability insurance package with a gap so large you could drive a truck through it, so to speak?

Typically, CGL and auto insurance are designed to be mutually exclusive.  Policyholders expect to be covered for bodily-injury claims one way or the other.  The typical CGL policy responds to injury actions that do not involve the insured's use of a motor vehicle; if the accident allegedly arose out of the insured's use of a covered auto, including loading and unloading of same, then its auto policy should cover the accident.  (The standard "Aircraft, Auto, or Watercraft" exclusion in a CGL policy excludes injuries "arising from the ownership, maintenance, use or entrustment to others of any ... 'auto' ... owned or operated by or rented or loaned to any insured.")  The typical auto policy covers, more or less, what the CGL policy excludes.

Under this standard arrangement, one would expect Bakersfield to be covered by the CGL policy because the accident did not arise from an auto connected with the city.  However, for whatever reason, Bakersfield's CGL policy excluded accidents arising from any autos whatsoever, including those that would not trigger coverage under the city's auto policy. 

The appellate court found that the city had a "reasonable expectation" that its CGL policy would cover accidents allegedly caused by a dangerous condition not involving any city autos and reversed the lower court.  The reviewing court noted that the city could not purchase insurance from any source that would cover this kind of accident, if the auto exclusion was allowed to stand as written.  That is true.  But I question the court's explanation that the city would have reasonably expected the amended exclusion to apply only to those accidents that in some way involved city vehicles.  The broader amendment seemed tailored to do just that.  A state, like Texas, that does not have this kind of reasonable-expectation magic wand would leave the city without coverage, at least in the absence of some kind of fraud-in-the-inducement evidence that the insurer told the policyholder that the exclusion would not have this broad effect.

The lesson for the policyholder is to lay its CGL and auto policies side-by-side and make sure cost-saving amendments (I am guessing the city got a lower premium fro the broader exclusion) do not leave unintended coverage gaps.

California Supreme Court Strikes Down Contractual Exculpation of Gross Negligence: Texas Is Still On the Fence

City of Santa Barbara v. Superior Court (Janeway), 161 P.3d 1095 (Cal. 2007).  See case at Janeway Decision.

In July of this year, the California High Court held that contractual releases of future claims for gross negligence in the context of sports and recreational programs were unenforceable as against public policy.  The case is well worth reading not only because of the court's thorough analysis of competing legal principles under California law (the freedom to contract vs. maintaining a reasonable standard of care in community life requiring wrongdoers to recompense injured parties), but also for its wide-ranging examination of the law of other states.  However, the court had little to say about Texas law on this issue because the Texas Supreme Court has never addressed the issue, and Texas state courts are divided. (A good analysis of this issue under Texas law is provided in Ryan S. Holcombe, "The Validity and Effectiveness of PreInjury Releases of Gross Negligence in Texas," 50 Baylor L. Rev. 233 (Winter 1998).

In Texas, as in most other states, a contract involving recreational or sports activities may contain a release or indemnity clause (a release voids liability entirely; an indemnity shifts liability to another) that is enforceable against ordinary negligence if it meets Texas's peculiar "Fair Notice" requirements. (For a discussion of these requirements, see Risk Shifting Agreements).  In effect, the release (indemnity) must expressly state that it releases (indemnifies against) the releasee's own negligence, and the release must be stated in boldface or other conspicuous language.

"Ordinary negligence" is the failure to use that degree of care that a reasonable person would exhibit under the same or similar circumstances.  "Gross negligence," under Texas's (again) peculiar standard is defined in Sec. 41.001 of the Texas Civil Practice and Remedies Code as:

conduct (A) which when viewed objectively from the standpoint of the actor at the time of its occurrence involves an extreme degree of risk, considering the probability and magnitude of the potential harm to others; and (B) of which the actor has actual, subjective awareness of the risk involved, but nevertheless proceeds with conscious indifference to the rights, safety, or welfare of others.

California and most other states define gross negligence as either a "want of even scant care" or "an extreme departure from the ordinary standard of conduct."  In the Janeway case, a girl drowned while participating in a county summer camp for developmentally disabled children.  Camp counselors were aware of the girl's propensity to seizures, and the girl's designated mentor was aware that the girl had suffered a mild seizure a short time before the incident, but she was allowed to dive into a pool and drowned when the counselor's attention was diverted for a few seconds.  The Court held that the parents' release was effective to release ordinary negligence but not gross negligence.

Some courts in Texas reason that negligence and gross negligence are not separate torts, and a release that is effective against ordinary negligence should also release gross negligence.  See Newman v. Tropical Visions, Inc., 891 S.W.2d 713 (Tex. App. --San Antonio 1994, write denied).  At least one other court has held that a release from gross negligence is against public policy and should not be enforced.  See, e.g., Smith v. Golden Triangle Raceway, 708 S.W.2d 574 (Tex. App.--Beaumont 1986, no writ).  The Texas High Court has yet to decide the issue.

My best guess is that Texas will follow California on this issue.  Cases like Newman that put negligence and gross negligence in the same bucket rely on pre-1990's thinking before the Texas Supreme Court decided Transportation Ins. Co. v. Moriel, 879 S.W.2d 10, 23 (Tex. 1994), which established a brighter line between negligence and gross negligence.  The Moriel court observed that juries were not given a sufficient criterion for deciding when punitive damages for gross negligence were appropriate.  Logically, the reasoning in Moriel suggests that negligence and gross negligence should be considered separate categories.

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

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

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

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

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

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

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

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

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California Court Says Settlements Are not "Damages" Without An Adjudication

Aerojet-General Corp. v. Commercial Union Ins. Co., #CO51124 (Cal. App., Sept. 13, 2007)

This case should serve as a warning to policyholders to read their policies closely (and with their legal hats on).  "Damages" was held to mean "legally obligated to pay or by final judgment be adjudged to pay," and would not include settlements reached out of court, even if the court approved the settlements.  Thus, the policyholder lost its right to recover $175 million, otherwise covered, because it settled rather than submit to actual trial.

Aerojet sought indemnification from several of its excess liability insurers for the cost of remediating groundwater contamination as a result of a number of lawsuits filed in 2000 and 2001.  If the insurers asserted coverage defenses over the merits of the claims, the case doesn't mention them.  It appears that the excess policies were in effect before 1970 and thus, before pollution exclusions.  Aerojet kept the excess carriers informed of the settlement talks but apparently did not obtain their consent to settlements reached with the claimants.

The California Supreme Court has already held in Certain Underwriters at Lloyd's of London v. Superior Court, 16 P.3d 94 (Cal. 2001) [Powerine I] that the term "damages" operated to limit the insurer's obligation to indemnify only to money ordered by a court and would not include environmental cleanup costs required by an administrative agency.  The California Supreme Court in a later opinion in the Powerine case [Powerine II], found that policy language requiring the insurer to indemnify "expenses" as part of the definition of "ultimate net loss" was enough to require an excess insurer to pay.

Unfortunately for Aerojet, its polices did not include the "ultimate net loss" definition or define "damages" in any way that would expand Powerine I's narrow interpretation.  Therefore, the excess insurers were not required to indemnify the (otherwise covered) settlement payments.

While Aerojet's policies were written more than 50 years ago and so contained standard language no longer in use, the lesson to be learned is still valid.  Policyholders should read their policies and have coverage counsel review the language in light of current legal trends.

Judge Dismisses Antitrust Claims Against Insurers and Brokers Over Alleged Contingent Fee/Bid Rigging Practices

A federal district court judge in New Jersey ended a huge antitrust lawsuit against dozens of the nation's largest insurance companies and brokers alleging conspiracy to allocate customers and fix prices.  Policyholders, both corporate and individual and interested public agencies brought the lawsuit concerning practices first scrutinized by the New York Attorney General in 2004 in which certain insurance brokers allegedly received undisclosed or inadequately disclosed commissions, so-called "contingent commissions," from insurers for preferential placement of business and solicited phony bids from some insurers in bid-rigging schemes.  Since 2004, many brokers have promised to cease taking contingent commissions, and RIMS, a national association of risk managers, has condemned the practice.  See RIMS.  Moreover, many of the participants have paid regulators millions in settlements.  See, e.g., Marsh settlement.

The Judge Garrett E. Brown Jr threw out the lawsuit writing that the "hub and spoke" conspiracy "is devoid of a factual basis for this court to infer that an agreement existed among the competitors - in this case, the insurer defendants."  The plaintiffs failed to show a horizontal agreement among the insurer defendants to divide the brokers' business and refrain from competition.  Judge Brown also concluded that the plaintiffs failed to demonstrate a global conspiracy among the broker defendants to hide the existence of "contingent," or bonus, commissions from their own clients, or the clients of another broker in an effort to steal that broker's clients.  For a fuller discussion of this dismissal, see Judge Again Dismisses Lawsuit.

Indiana Appellate Court Holds That Companies Acquiring a Predecessor May Seek Coverage From the Predecessor's Occurrence-based Liability Policies Even Without the Insurers' Consent

Most commercial general liability (CGL) insurance policies contain anti-assignment clauses stating that the policyholder may not assign the right to receive proceeds and other policy benefits to another without first obtaining the insurer's consent.  Up until a few years ago, the law of most states was that once a covered loss had occurred, the anti-assignment clause would not prevent the transfer of insurance rights to a purchaser.  Take, for example, fire insurance on a house.  If I purchase an insurance policy on my house and sell the house to another, the insurer may refuse to cover a fire loss if the house burns down after the sale.  The reason for this is that the insurance company has the right to decide whether the owner is a worthy risk.  The insurer has the right to decide if I am a careful property owner who will take care to avoid fire risks.  The person buying my house may not be so careful, so the insurer has the right to refuse to transfer the policy benefits to someone else.  But if the fire occurs before the sale, then arguably the insurer should not be able to refuse to pay for the loss, even to the purchaser, because the risk at the time of the loss was the same as the insurer had originally bargained for.  That, at any rate was the majority position.

In 2003, the Supreme Court of California reached a different conclusion in Henkel Corp. v. Hartford Acc. and Indem., 62 P.3d 69 (Cal. 2003), holding that rights to coverage under a CGL policy could not be transferred without the insurer's consent, even though the covered event had occurred before the sale of the policyholder to a successor company.  The Henkel court's reasoning was based on fairly arcane principles of property law that boiled down to a determination that a right to liability insurance proceeds was freely transferable (without the insurer's consent) only after that right was reduced to a fixed monetary sum.  The benefits due under a CGL policy are the right to a defense of a lawsuit and payment of a judgment or settlement of covered liabilities.  Those rights are reduced to a fixed amount only after a lawsuit is brought and resolved.  When one company purchases another, the purchaser usually assumes the seller's existing liabilities that arose out of conduct that may have occurred years before the sale.  Occurrence-based CGL policies cover liability-causing events occurring within the policy period, so the purchaser expects to receive, along with the seller's liabilities, the benefit of the seller's CGL policies in effect at the time of the occurrence.  The purchaser then must face the post-sale lawsuits for those pre-sale liabilities.  The Henkel case denied the purchaser the right to coverage without the consent of the insurer.

Now, the Indiana Court of Appeals has reached an opposite conclusion in Travelers Cas. and Sur. Co. v. United States Filter Corp., 2007 Ind. App. LEXIS 1661 (July 24, 2007).  In this case, U.S. Filter Corp. had purchased a company that had changed hands several times in the past but had continuously manufactured a product known as a "wheelabrator blast," a piece of heavy machinery that throws off silica as a by-product, thereby creating lots of silicosis liability over the years.  The court took note of the California precedent but cited a U.S. Supreme court case, Century Tablet Mfg. Co. v. United States, 94 S. Ct. 2516 (1974) for a distinction between the assignability of rights to insurance proceeds as opposed to other contract rights.  The key distinction is that, once a covered loss has occurred, the casualty is fixed and cannot be rescinded in the same was that an executory contract to sell may be rescinded.  Therefore, the Indiana court held that the purchaser obtained rights to coverage when it received the predecessor's liabilities.  The anti-assignment clauses in those CGL policies did not cut off rights to coverage because the covered occurrence were fixed at the time of sale.

It remains to be seen which way courts in other states will go.  For the record, Texas has long been in the minority holding that an anti-assignment clause prevents a purchaser from obtaining coverage even if the occurrence preceded the sale.  See Insurance Co. of Penn. v. Hutter, 2001 U.S. Dist. LEXIS 5800 (N.D. Tex. 2001).

9/11 Court Requires Insurance Company and Attorneys To Pay Sanctions For Deleting E-Version of Policy

Mishandling e-discovery in litigation has become a tremendous trap for unwary and unprepared companies and their counsel.  Indeed recent amendments to the Federal Rules of Civil Procedure impose rules for handling the identification and production of electronically stored records.  For a discussion of these rule changes, see E-Discovery Rule Changes.  Zurich American Insurance Company and its attorneys have become the latest to be hit with costly monetary sanctions for failing to preserve and produce electronic documents.

Judge Alvin K. Hellerstein of the Southern District of New York recently ordered Zurich and two law firms representing it to pay $125 million for failing to produce a 62-page electronic version of of a primary liability policy that was at the center of the insurance dispute over coverage for 9/11 damage to World Trade Center properties.  The version of the policy as it existed (but not yet delivered) on September 11, 2001 gave "additional-insured" status to several entities, including the Port Authority of New York and New Jersey.  But in November of that year Zurich actually delivered a version of the policy that did not include the endorsement.

In subsequent coverage litigation, Zurich denied that the additional insureds were entitled to coverage.  Evidence showed that Zurich deleted the electronic version of the policy that would establish that the underwriters had agreed to include the additional insured endorsement.  However, a paper copy of the e-document later turned up, although attorneys for Zurich refused for almost two years to turn it over to the other side.  The court imposed the sanctions in part to reimburse the additional insureds for the expenses of pursuing discovery of the document.

Justices Impose Greater Burden on Investors in Securities Fraud Actions

The United States Supreme Court ruled yesterday that investors suing companies and their directors for securities fraud should not be permitted to proceed with their action unless they can "state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind," which the law defines as "the intention to deceive, manipulate or defraud" (generally called "scienter," Latin for "knowingly" or degree of intentionality).  In the Private Securities Litigation Reform Act of 1995, Congress required the showing of a "strong inference" of scienter but provided no guidance to the courts as to what that means.

In this action. investors sued Tellabs, Inc. and its CEO for allegedly overstating revenue projections.  The lower court had held that the suit should be allowed to go forward if a "reasonable person" could infer that the person acted with the required intent.  Speaking for the 8-1 majority of the high court, Ruth Bader Ginsburg rejected this standard and held that “The inference of scienter must be more than merely ‘reasonable’ or ‘permissible’ — it must be cogent and compelling, thus strong in light of other explanations.”   The lone dissenter, John Paul Stevens, said that he would require "probable cause," the standard required in a criminal indictment, arguing that Congress would not placed a high burden on a plaintiff in a civil action than is required of the state in a criminal proceeding. 

This decision is seen as a significant victory for public companies.  For a fuller description of the Tellabs decision, see N.Y. Times article.

U.S. Supreme Court Holds Insurers' To a Lenient Standard Under the Fair Credit Reporting Act

It is rare for the U.S. Supreme Court to weigh in on insurance matters, but interpretation of the Federal Fair Credit Reporting Act (FCRA) that requires companies to notify consumers in "adverse action notices" about rate increases that are based on information in their consumer credit reports is a matter for the federal courts.  In a victory for insurers Geico Corp. and Safeco Corp., the high court reversed a Ninth Circuit Court of Appeals decision and held insurers do not have to send adverse action letters to consumers that would have received a lower premium had their credit scores been higher.  The safe harbor for insurers is that no notice is required if the premium offered is no higher than would have been offered if the credit score had been ignored.  In other words, a consumer may not be punished with a higher rate for a bad score without notification, but the insurer is not required to reward consumers by notifying them that they would receive a lower rate with a better score.  Insurers are relieved by this decision.  See Insurance Journal Report for more.

New York Court Opens Potential New Channel to Insurance Coverage for Contractor’s Asbestos Liability

Will insurance coverage for asbestos liability ever run dry?  Last week, a lower New York court held that some 17 general liability policies whose “products hazard/completed operations” coverage had been exhausted by asbestos claims years ago could now be tapped for “premises/operations” coverage, exposing the insurance companies involved to significant, perhaps even unlimited, liability to a new class of asbestos personal-injury plaintiffs.  If followed by other courts, this ruling could greatly expand asbestos liability coverage for some defendants.

In Continental Casualty Co. v. Employers Liability Assur. Co., 2007 NY Slip Op 27188, 2007 N.Y. Misc. LEXIS 3336 (N.Y. Sup. Ct. May 8, 2007), a class of some 20,000 workers sought recovery for alleged asbestos-related injuries incurred while working on the same construction sites where a certain insulating company was installing or removing asbestos products.  CGL insurers for the company had already defended and settled a number of claims under the so-called “products hazard/completed operations” portion of the policies.  As the name implies, this provision covers injury or damage incurred after an insured’s product has been manufactured and put into the stream of commerce or after the insured’s work has been completed and the insured has left the premises.  Thus, the insulating company’s earlier settlements were for claims alleging exposure to the insured’s products or completed workmanship after the construction phase is over.  By May of 1992, the insurers in this case had already paid out combined aggregate limits of $8,700,000 under the products hazard/completed operations coverage.  Most insurance coverage for asbestos products liability has been through this type.

By contrast, “premises/operations” coverage in the CGL policies pays for injury incurred on the job site, while the insured is still performing work on the premises.  The new plaintiffs in the current action allege that they were working around the insulation contractor and were injured by asbestos exposure caused by the insured’s ongoing work.  The plaintiff class also asserts that the policies contain no aggregate limit on premises/operations coverage, only a per-occurrence limit, and that the insurers’ ultimate exposure “could be perpetual.”  The court estimates that the damages at issue could be as high as $250,000,000.

Relying on  a 1997 New York Court of Appeals decision in Frontier Insulation Contractors, Inc. v. Merchants Mutual Ins. Co,, 91 N.Y.2d 169 (NY 1997), the lower court held that the CGL insurers could be held liable to pay both products hazard/completed operations and premises/operations claims, as the two coverage provisions applied to different types of claims.  Even if the completed operations limits had been exhausted, the premises/operations coverage was still available as long as the plaintiffs prove they were exposed during the insured’s ongoing operations.

Given that, historically, liability insurers did not include aggregate limits in their policies during the 1970’s and earlier, this decision may prove costly to the insurance industry if followed by other courts.  Policies thought to have been exhausted may now be given a second look by asbestos claimants.

California Federal Appellate Panel Rules that Insurers May Deny Claims Without Violating Bankruptcy's Automatic Stay

In Benz vs DTRIC Insurance Company (In re Benz), 2007 DAR 5158 (9th Cir BAP 2007), filed March 28, 2007 and published April 18, 2007, the Bankruptcy Appellate Panel for the 9th Circuit ruled that an insurer may determine its obligations under an insurance policy [here, an automobile policy], and act consistently therewith [i.e., by declining or refusing to continue to defend or indemnify an insured/Chapter 7 Debtor], without violating the Automatic Stay of 11 USC Section 362(a) that arises upon the bankruptcy filing. An insurer still may not cancel any insurance policy issued to the debtor in bankruptcy, and should not sue the debtor for declaratory relief over coverage, without first obtaining consent of the bankruptcy court.  However, this recent decision should allow carriers to adjust claims and reject clearly uncovered claims without involving the bankruptcy court.

Federal Jury Awards $2.8 Million for Katrina Loss

Was the damage caused by wind or water?  That has become the crucial issue in most of these Katrina-related property damage cases.  In this case, a federal jury found that Robert Weiss's home was damaged by wind and hit Allstate Insurance Company with a sizable verdict, including $1.5 million in extra-contractual damages for failure to pay covered damages promptly.  The insurer argued that Mr. Weiss had already received $400,000 from flood insurance and other insurance and that wind could not have caused the extensive damage to the structure.The jury disagreed and found that this amount was not sufficient to pay for the wind damage.  See story at MSNBC.

Supreme Court Ruling on Greenhouse Gas Regulation Could Have Direct Impact on D&O and Environmental Insurance

The U.S. Supreme Court's remarkable decision in Massachusetts v. EPA (see text of opinion) requiring the EPA to reconsider its decision not to regulate greenhouse gases has ramifications beyond environmental regulation.  By holding that carbon dioxide may be a "pollutant" and so may be regulated under the Clean Air Act, insurers are armed with a powerful argument that corporate losses and liabilities that arise from the effects of global warming are excluded under insurance policies that contain a pollution exclusion.  These might include general liability policies, property policies, directors and officers ("D&O")liability policies, and other types of liability insurance.  Each of these is likely to contain an exclusion for loss or damage arising from an actual or alleged discharge, dispersal, release, or escape of "pollutants."

The area of greatest concern to corporate policyholders is probably D&O insurance. Many companies are just now beginning to try to access risks to their businesses from the effects of global warming.  The Supreme Court discussed the scientific data predicting imminent rises of sea levels.  It is easy to foresee a slurry of shareholder class action lawsuits against companies adversely impacted by global warming alleging management's failure to adequately anticipate and prepare for these changes.  Because greenhouse gases are "pollutants" according to the Supreme Court, arguably, these shareholder actions could be excluded because the alleged losses arise, even if indirectly, from the release of greenhouse gases. 

For a thoughtful discussion of this Supreme Court decision, see law and environment.