still more bathroom reading, "insurers will have a duty to defen

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May 22, 2007
On Suits and Prophylactics: Recurring Environmental Coverage Issues

Commercial general liability policies provide coverage for the insured’s liability for “damages” on account of bodily injury and property damage and require the insurer to provide a defense to “suits” seeking such damages. Since the beginning of the environmental liability coverage wars some twenty-five years ago, insurers have disputed whether their insureds’ environmental liabilities seek to impose “damages”, are on account of “property damage,” and are adjudicated in the context of “suit[s].” Recent cases have continued to address these recurring issues.

In Cinergy Corp. v. Associated Electric & Gas Insurance Services, Ltd. (Ind. May 1, 2007), the Indiana Supreme Court considered whether the insured’s liability in that case was in the nature of “damages.” The Indiana court granted the insured a somewhat pyrrhic victory in finding that the insurers in theory had obligations to defend, but holding that the liability for which the insured ostensibly was liable was not of the nature of a monetary obligations to which liability insurance applies. The court gave the insured some sympathy in dealing with the policy language: “Synthesizing the policies’ insuring agreements with their respective definitions of capitalized words and phrases is a daunting task, replete with often confusing, redundant, and sometimes circular concepts.” Slip op. at 7.

But the court held that the liability in the civil action in which the insured was involved was not of the nature and kind covered by liability policies. “There is essential agreement among the parties . . . that the primary thrust of the federal lawsuit is to require the [insured] to incur the costs of installing government-mandated equipment intended to reduce future emissions of pollutants and prevent future environmental harm.” Slip op. at 11. In assessing whether there was coverage, the court adopted the now-familiar distinction between (covered) “remedial” and (uncovered) “prophylactic” measures. The court ruled that the government’s action against the insured was “directed at preventing future public harm, not at obtaining control, mitigation, or compensation for past or existing environmentally hazardous emissions.” Slip op. at 14. Consequently, the court found that the liability of the insured was not as a result of “the happening of an accident, event, or exposure to conditions but rather [was directed at] the prevention of such an occurrence.” Slip op. at 15.

In effect, the court found that the liability involved was not as a result of any past or existing property damage, but rather was based only on complying with legal requirements to conduct its operations safely. (Alternatively, the court could be said to have found that there was no property damage yet for which the insured was being held liable.) Accordingly, “the costs of installing government mandated equipment intended to reduce future emissions of pollutants and to prevent resulting future environmental harm” does not constitute covered sums for which the insured is liable because of property damage. Slip op. at 16.

The “remedial” versus “prophylactic” distinction in the environmental context is often elusive (and for that reason alone courts should be chary of denying coverage for bona fide liability). While it is true that insurance policies are not funding mechanisms for the costs of operating in compliance with the law, where property damage has occurred and an element of the damages on account thereof include measures to prevent the recurrence of damage, then the costs of those future-oriented remedies should be (and generally are) covered. When one is dealing with water contamination or air contamination, for example, it may be that the remedy includes measures to reduce the concentrations of the deleterious substance released by the insured; by limiting additional releases of that substance, the water system, for example, is able to dilute the contaminants through ordinary recharges of the system and reduce the concentration below the level of “damage.” In this way, stopping the on-going contribution of the deleterious substance can be thought of as a remedy for past damage (because this type of preventive remedy allows the damage to be mitigated). Were one to freeze-frame the issue, however, and look only at the remedy (and not the reason for the remedy), it might be argued that the measure is “prophylactic,’ that is, is meant to prevent the future release of contaminants.

For purposes of analyzing the availability of insurance-coverage, however, the question is why is the insured responsible for containing future releases. Where there has already been damage for existing releases of contaminants, “stop[ping] that ongoing release is not mere prophylaxis.” Watts Industries, Inc. v. Zurich American Ins. Co., 121 Cal. App. 4th 1029 (2004)
.

In legal proceedings where the insured faces liability for “damages,” primary CGL insurers will have a duty to defend. Where there is no possibility, however, that the action against the insured can eventuate in a judgment covered by the insurer’s duty to indemnify, then the insurer will not have an obligation to defend. Because in Cinergy the Indiana Supreme Court held that the costs at issue were purely prophylactic and not “damages because of property damage,” the court ruled that the insurers had no duty to defend (though rejecting the rationale of the court below that there was a duty to pay defense costs only as an incident to the obligation to indemnify and thus only after the underlying action was concluded). Cinergy, slip op. at 16.

Even if the insured faces bona fide damages, the duty to defend applies to “suits,” and naturally insurers and insureds have joined issue on whether various types of proceedings constitute “suits” to which the duty to defend extends. Most courts have recognized that enforcement proceedings that can eventuate in a “damages” award are in the nature of a “suit” against the insured, but some courts have equated the term “suit” with “lawsuit” and held that only actions in a court of law – as opposed to an administrative proceeding – can constitute a “suit.” That said, even these jurisdictions may allow a claim for the cost of defense of a non-traditional or non-court proceeding where “suit” is defined more broadly to encompass other forms of liability-seeking actions or where the insurer’s obligation to pay includes obligations to reimburse “expenses” incurred in the defense, without those expenses being tethered only to court-proceedings. The recent decision of the California Court of Appeal in Ameron Int’l v. Insurance Co. of State of PA (Cal. App. May 15, 2007) analyzes a number of different formulations of insuring obligations, cast against the backdrop of decisions holding that the undefined term “suit” is limited only to actions in a court of law. Ameron is a useful reminder to policyholder and insurer lawyers that we need to parse the language of the contract carefully in determining the obligations to provide coverage vel non.

Posted by Marc Mayerson at 12:31 AM | Comments (1) | TrackBack
May 21, 2007
Odoriferous Occurrence

Anaerobic decomposition produces among other things hydrogen sulfide gas. It is this gas that makes flatulents distinctive from, shall we say, the bouquet of a rose. This was illustrated in a recent coverage case involving a Minnesota pig farm that created a concrete lagoon with capacity to hold 1.5 million gallons of manure. Three-quarters of a mile away was a neighbor’s home.

The homeowners were none too pleased with the “extremely noxious and offensive odors and gases” that impeded their enjoyment of their home; so they sued the pig farmer for, among other things, creating a nuisance. The farmer turned to its insurer to defend arguing there was covered property damage – the homeowners’ loss of the use and enjoyment of their property (i.e., loss of use of tangible property that is not physically injured) arising from an occurrence.

Overturning part of the ruling of the trial court in favor of the insurance company, the Minnesota Court of Appeals held that the choice to locate the manure lagoon, while deliberate, resulted in an occurrence. Wakefield Pork, Inc. v. RAM Mut. Ins. Co., (Minn. App. May 15, 2007). The lagoon was in compliance with state environmental regulation and zoning ordinances. As a result the Minnesota court reasoned: “it would be inconsistent for this court to acknowledge, on the one hand, that appellant’s hog operation is legally operated and fully compliant with all applicable regulations, but to conclude, on the other hand, that appellant acted with a willful disregard or intent to harm its neighbors.” Slip op. Reasoning that the insurance company would have known at the time of underwriting that pig farms produced noxious gases, the court was reluctant to hold that the ordinary operations of the farm was uninsurable.

Nevertheless, the court held that the policy did not provide coverage because of the pollution exclusion, which barred coverage for liability on account of “fumes.” Because foul odors – or porcine odors – were gases released from the decomposition process, the Minnesota court held these were plainly encompassed within the pollution exclusion. As a result, the insurer had no duty to defend.

Posted by Marc Mayerson at 2:04 PM | Comments (0) | TrackBack
October 26, 2006
Trigger and Allocation for A*****estos, Other Bodily Injury, and Property Damage: Recent Cases and the Policyholders' Winning Argument

“Who pays” and “how much” continue to be central questions in insurance-recovery litigation by policyholders for a*****estos, environmental clean up, pharmaceutical, lead-paint, toxic-tort and other conditions that produce loss over time. Because insurance contracts are governed by state law, the coverage wars apparently will continue until each inch of turf is won or lost. Most recently, the Delaware Supreme Court has weighed in on the question of trigger of coverage (“who pays”) for a*****estos- liability claims, the Minnesota Supreme Court has addressed allocation of loss (“how much”) among triggered policies, and the New Hampshire Supreme Court has now been asked to address the allocation question, too.

The Delaware and Minnesota cases suffer from an overly conceptualist approach to looking at the questions presented; instead of applying the contract language, these courts have applied “models” of how the coverage should apply. As these cases show, misframing the question to be answered results in answers that are not entirely satisfactory or coherent.

Starting with Delaware: The question presented in Shook & Fletcher A*****estos Settlement Trust v. Safety National Cas. Corp. (Del. Sept. 26, 2006) was what event must occur during the policy period in order for an occurrence policy to be activated (triggered). An insurer has no obligation to perform unless the claim against the insured triggers (or potentially triggers) its coverage. Shook & Fletcher was decided under Alabama law. As noted by the Delaware court, in prior coverage litigation “after full briefing and argument, the Alabama court held that the ‘exposure coverage theory’ would apply, instead of the ‘continuous trigger’ or ‘triple trigger’ theory.” Slip op. at 3-4.

The Delaware Supreme Court in trying to predict Alabama law sought to resolve the question in part by counting noses among state Supreme Courts and federal appellate courts. As the court explained: “We have analyzed the cases where the parties disagreed upon which trigger theory the court actually adopted. Our analysis shows that the exposure trigger is the majority rule.” Slip op. at 9. The court found that Pennsylvania, New Jersey, Delaware, and the Third and D.C. Circuit’s have adopted a continuous trigger; but the Court’s analysis of the other cases led it to conclude that the following jurisdictions have adopted an exposure trigger for a*****estos bodily injury claims: Louisiana, Massachusetts, Maryland, Illinois, Fourth Circuit, Fifth Circuit (Texas), Fifth Circuit (Louisiana), Sixth Circuit (Ohio), Sixth Circuit (Michigan), Eleventh Circuit (Alabama), and the First Circuit.

Holding aside that I quarrel with the court’s table and analysis of cases, the court thus concluded: “We rely on the rationale of those cases and the fact that the exposure trigger is the majority rule.” Slip op at 11.

The Delaware court offers no analysis of the issue on its own but rather tries to predict what the Alabama Supreme Court might do. In this context, it is passing strange that the court does not address on the merits its own prior continuing-injury trigger decisions or come to grips with the rule of construction – applicable in Alabama – that if the policy language admits of more than one reasonable construction the court is to construe the language in favor of coverage. Compare Hercules Inc. v. AIU Ins. Co. (Del. Aug. 15, 2001) (finding plain language compels an “all sums” allocation as do equitable considerations). Is the Delaware court now saying that its own prior decision was unreasonable?

In Shook & Fletcher, no effort was made to look at the policy language. And the language is straightforward: insurance policies like those in Shook & Fletcher are triggered if injury occurs during the policy period. Trigger is the issue of what event must take place during the policy period, and the policy is clear – it is not the occurrence, the exposure, or the accident: trigger is “injury.” While “injury” may follow from “exposure,” the difference is one between cause and effect, and typically liability policies are triggered by the effect. (The number of occurrences is determined by causes, but that is a different legal and contractual issue.)

Policyholders should not argue, as I have sometimes seen them do, that there are as many as eight different trigger theories out there and the job of the court is to pick one. Rather, the policy language is absolutely clear that injury is the trigger, and the only question is whether, in the particular context before the court, can whatever happened during the policy year under scrutiny reasonably be construed to be “injury.”

So, the right way for policyholders to argue is not to serve up the question as “which trigger applies: exposure, manifestation, continuous”? The right question is: “Because the trigger is injury, did injury occur during this policy period?” For policies in effect during the period of exposure, one argues that following exposure the body suffers injury. For policies in the period after exposure but while the a*****estos fibers persist in the body, one argues that the continued presence of a*****estos in the body produces a reaction such that that further effect constitutes injury that year. For policies in effect during the period that an a*****estos-related disease is diagnosed, one argues that under the definition of bodily injury – which includes “bodily injury [and] disease” – there is disease and thus injury during the policy period.

It doesn’t matter whether we are arguing about a*****estos, or pharmaceutical, or lead paint, or toxic torts: the question of trigger under “occurrence” CGL policies is injury.

A policy’s being triggered does not answer the question of how much the triggered policy is required to pay for the insured’s loss. The “how much” question is known variously as “allocation” or “scope of coverage.” The Minnesota Supreme Court recently weighed in on allocation of coverage, but in doing so it had to deal with prior authority holding that a continuing-injury scenario triggered multiple policies across time and that presumptively each insurer’s obligation to perform was dependent on the quantum of injury that occurred in its policy year. So for illustration, if damage occurred in a steady-stream way for 10 years and caused $10 million in damages, then $1 million would be allocated per year, no matter that in some years the insured bought much more coverage or that in other years the primary layer was, e.g., $200,000 and in other years it was $50,000.

In Wooddale Builders, Inc. v. Maryland Cas. Co. (Minn. Oct. 8, 2006), the court confronted a number of questions concerning the implementation of this kind of scheme: if the damage occurs during only part of a year, does the carrier have to pay its full limit? What happens for years in which there is no coverage? Can the insured buy more coverage once it has knowledge of the problem?

The Court framed the basic issue as follows:

The relationship [among the policies] can be expressed – and perhaps best understood – in terms of a simple equation: A/B x C = D. In this equation, A is each insurer’s time on the risk, B is the total period over which liability is allocated, C is the total damages to be allocated, and D is the damages allocated to each individual insurer.

The court first addressed whether the coverage period is cut off at some moment due to the insured’s knowledge of the risk of liability. In Wooddale, the case involved damage to a number of homes that had been built, and the court ruled that once the insured had knowledge that a home had been damaged no further insurance available. The court ruled – in error – that damage was expected or intended (and thus excluded) once the insured had knowledge that some homes had been damage: “The practical effect of the policy language excluding expected damage and the rationale behind the known loss/loss in progress doctrine is that no additional insurance policies are triggered by continuing damage to homes for which claims had been made before those policies took effect. . . . We therefore hold that only insurers that provided coverage to Wooddale between the closing date of a particular home and Wooddale’s receipt of notice of claim with respect to that property are on the risk for that claim.” (fn. omitted).

(The court’s cutoff based on these theories is wrong because expected/intended damage is meant to stop the insured from acting or setting in motion the chain of events leading to damage rather than policing the insured’s knowledge of a ticking time bomb – the right mechanism to protect insurers on this point is nondisclosure; and known loss is not properly applied here either because from an insurance perspective there is insurable risk, and thus no known loss, so long as there is uncertainty as to whether, when or how much liability will be found – again, all subject to non disclosure rules. See Transamerica Ins. Group v. Meere, 694 P.2d 181, 186 (Ariz. 1984) (“"The exclusion 'is designed to prevent an insured from acting wrongfully with the security of knowing that his insurance company will "pay the piper" for the damages.'''); Bob Hedges, Back-Dated Coverage as Insurance, 34 CPCU J. 181, 181 (1981). And the court does not address equities such as whether the policyholder paid premium in effect for this risk exposure that the carrier gets to pocket under the court’s analysis.)

The court further examined the consequence on an insurer’s obligation to pay from the trigger cutting off during its policy period, or put differently is the insurer that provides coverage for only part of a policy year required to pay its full limit? Here, the court got the answer right, but because its rationale is embedded within the pro-rata-by-quantum-of-damage methodology its reasoning is a bit unsatisfactory. The court offered only the rationale that it was aware of no basis for concluding that a full limit does not apply. “Instead, each of the policies provides coverage for ‘property damage’ that ‘occurs during the policy period,’ indicating that the insurer has agreed to indemnify the insured for damages that occur during the entire policy period, including the part of the policy period that runs after notice of the claim.”

The court does not address the case law on “stub policies,” that is, the limits available in a part year policy by analogy (as opposed to a full year policy with only part damage). Stub policy case law uniformly recognizes that the carrier’s policy limits are at risk every day of the policy, and that the premium is paid for the availability of the full limits each day. See United States Mineral Products Co. v. American Ins. Co., 792 A.2d 500, 502 (N.J. Super. App. Div. 2002); Stonewall Ins. Co. v. ACMC, 73 F.2d 1178, 1216-17 (2d Cir. 1995); Cadet Mfg. Co. v. Am. Ins. Co., 391 F. Supp. 2d 884, 890 (W.D. Wash. 2005). More importantly, the allocation method that the court has previously embraced does suggest only a partial limit for part-year damage, and the court does little to explain other than offer its ipse dixit.

The court reached the parallel conclusion for policies in effect during the year in which damage first occurred, likewise holding that the full limits were available in the allocation formula.

Finally, the court considered whether periods of no insurance counted in the allocation formula, and the court divided periods of no insurance into (i) periods where the insured elected not to purchase insurance voluntarily (self-insurance) and (ii) periods where due to market forces there was no insurance to be purchased. The court concluded that allocating to periods of self-insurance was fair but that allocating to periods of no insurance was not, and so periods where there was no insurance get removed from the denominator of the allocation formula.

This has always been an unsatisfying approach, in part because it makes the contractual obligations of a party with a closed period dependent upon failures in insurance markets years later perhaps (because if a later period of no insurance is not included in the allocation formula each insurer’s relative share of the pie goes up). It accomplishes the objective of avoiding penalizing the insured for no “fault” of its own, but it also is somewhat naïve in its assessment of insurance markets and whether some underwriter somewhere might be willing to insure some risk for some ridiculous price (as the London market saying goes, there is no bad risk, just a bad price). So even though there was a worldwide conspiracy among insurers and reinsurers to cut off a*****estos coverage in the mid 1980s, if an underwriter wanted to sell a*****estos insurance doing so would not violate any positive law or prohibition against meretricious contracts. These are, to my way of thinking, too unstable of bases to support a rationale for how to apply an insurance contract that may have been written decades before.

Overall the Minnesota court made the following simplifying assumptions in its mathematical formula:

a. Each policy in effect during when any damage occurred is exposed for its whole limit.

b. Policies incepting after the insured expected claims have no obligation to perform.

c. A policyholder should be treated as if it were an insurance company if it voluntarily elected not to purchase insurance in the commercial markets.

d. A policyholder should not be treated as an insurer if the reason it did not purchase insurance is through no fault of its own.

Based on these elaborations, the court held that as to the duty to indemnify each carrier’s obligation to pay can be derived. (The court however embraced a per-capita allocation for defense.)

The Minnesota court recognized that its elaborations meant that its formulaic approach was becoming unmoored from the principles from which it derived. (No matter; such is the privilege of being the last word.) As the court said:

We are aware it is possible under our construction of factor B that an insurer is liable for more than those damages than would otherwise be deemed to have occurred during its policy period. This is possible because our definition of factor B, the period over which damages are to be allocated, excludes periods during which the insured lacks coverage because no such coverage was available. We are also aware that this result may be contrary to the broad language we used in [prior authority] to describe the ‘actual injury’ [trigger] rule, namely, that under this rule each insurer is liable ‘only for those damages which occurred during its policy period.’ [citation omitted] However, as we [there] indicated . . . ., the allocation of liability between insurers requires a flexible approach. [citation] Further, as we noted [previously], it is inaccurate to conclude that a CGL insurer can never be liable for damages occurring outside of a policy period. [citation] We deem the facts of this case to justify a departure from the typical ‘actual injury’ approach.


So is there a principled way to come to grips with the language of the insurance policy and figure out a principled manner to determine the obligation of each carrier where a single loss situation produces damage and injury both during and outside of its policy period? This is now the question that the New Hampshire Supreme Court has been asked in an environmental-coverage case. See EnergyNorth Natural Gas Inc. v. Certain Underwriters at Lloyd's Underwriters, 2006 U.S. Dist. LEXIS 73468 (D.N.H.)

I believe there is an approach to the contract language that takes the language seriously yet produces results that are (I submit) intellectually consistent.

The first principle is that insurance policies create rights in the insured, and it is the insured’s right to exercise. Insurance policies are not issued in dependence on the existence of coverage in other years; no credit is given on the premium from having more coverage in the past year than not or coverage from carriers with better credit ratings. Policyholders don’t promise carriers to purchase insurance policies in the future. And insurers are not understood to be third-party beneficiaries of each other’s contract, even though those contracts are with the same party, the policyholder. See Signal Co., Inc. v. Harbor Ins. Co., 27 Cal. 3d 359, 369 (1980); L.E. Myers Co. v. Harbor Ins. Co., 394 N.E. 2d 1200 (Ill. 1979).

The second, and more important, principle is that insurance policies insure against the risk that the insured will be held liable for injury or damage during the policy period; policies do not insure against the risk of injury or damage occurring per se. As one leading treatise explains, “[t]he hazard insured against under the liability feature is not injury or loss . . . but liability or responsibility of the insured for loss or injury.” 6B J. Appleman & J.A. Appleman, Insurance Law and Practice §4254 at 26-27 (Rev. ed. 1979). The policy language makes this plain. CGL policies contain a broad promise to pay “all sums” that “the insured shall become legally obligated to pay as damages because of bodily injury . . . to which this insurance applied caused by an occurrence.” In other words, subject to the applicable limit of liability, the policy covers the totality of damages incurred by an insured “because of,” i.e. “by reason of” or “on account of,” bodily injury within the policy period. The question then is, what is the insured’s liability because of the injury during the policy period. This is key and shows both where Minnesota law goes wrong and creates the hydraulic pressure on the court to backfill we see so clearly in Wooddale.

These two principles illuminate the right way to argue the point for policyholders (and I submit the right way for courts to resolve the question). Instead of the Minnesota court’s mathematical formula, one takes a single policy and asks the following question: Is there bodily injury or property damage that occurred during the policy period, and if so what is the insured’s liability for the bodily injury or property damage that happened? (Contrary to what some insurers have argued, the “Policy Period; Territory” provision does not alter the question, because that provision ensures that the trigger is damage, not the negligent act, see State v. Glens Falls Ins. Co., 609 P.2d 598, 600-01 (Ariz. App. 1980), and while the language in the insuring agreement referring to property damage “to which this insurance applies” refers implicitly to the “policy period; territory” provision, that does nothing to the question on which I focus, viz., what is the insured’s liability “because of” the property damage to which the insurance applies.) I don’t need to reflexively or exclusively rely on the insurance policy’s promise to pay “all sums” or “those sums” – that is handy language but is not the key issue. The key is always and only, what is the insured’s liability because of bodily injury/property damage during the policy period.

As a matter of tort (not insurance) law, in most of the situations we deal with the answer to that question is this: for bodily injury or property damage that occurred during the particular carrier’s policy period, the insured’s liability is equal to the entirety of the plaintiff’s claim. This is the result of the rule of tort law that imposes joint and several liability upon tort defendants. John Crane v. Scribner, 800 A.2d 727, 741 (Md. 2002) (“it is as impossible to ascertain which fiber ultimately caused which cell, over time, to escape the body’s defenses and turn cancerous, as it is to determine when that occurred”).

Note that I am not saying that insurers are jointly and severally liable under their policies; that would be to import a tort concept to the contract context, and I don’t think that is quite precise enough. But what is central is that the insured is jointly and severally liable, and such liability is imposed where the injury or damage at issue is indivisible from injury or damage that occurred in other policy periods (or from other tortfeasors). See United States v. Alcan Aluminum Corp., 964 F.2d 252, 268-69 (3d Cir. 1992); Matter of Bell Petroleum Services, Inc., 3 F. 3d 889-896 (5th Cir. 1993); O’Neil v. Piccillo, 883 F.2d 176 (1st Cir. 1989) (interesting discussions all re indivisible damage/injury and the imposition of joint-and-several liability under tort law).

Nothing in the policies reduces the carrier’s obligation to pay simply because injury may also have occurred outside the policy period; the sole determinant of the extent of coverage is what is the insured’s liability because of injury during the policy period. The policy language addressing the application of the policy limits for a covered claim nowhere confines the carrier’s obligation to pay to some aliquot share based on the quantum of injury occurring in its policy years. E.g., ACandS v. Aetna Cas. & Sur. Co., 764 F.2d 968, 974 (3d Cir. 1985) (Even where sums paid by the insured party are partly attributable to injury that occurred in another policy period, “the language of the policy makes [that fact] irrelevant.”).

This is made particularly clear in the “Limits” section of standard liability insurance policies. The “Limits of Liability” section of policies typically provides that, for a covered bodily-injury (or property damage) “occurrence,” the policy will pay for “all damages . . . because of bodily injury sustained by one or more persons as the result of any one occurrence.” The sole limitation on each policy’s obligation to pay is that the payout on the claim “shall not exceed the limit of bodily injury liability stated in the declarations as applicable to ‘each occurrence.’” The Limits provision further elaborates by stating:

For the purpose of determining the limit of the company’s liability [under the policy], all bodily injury . . . arising out of continuous or repeated exposures to substantially the same general conditions shall be considered as arising out of one occurrence.

Here the policy language unambiguously favors coverage: The amounts any given CGL policy pays are expressed in dollars “per occurrence.” The insuring agreement and the limits-of-liability provisions together teach that, where there is covered injury in the policy period, the policy pays “all sums” for “all damages sustained by one . . . person . . . as the result of any one occurrence,” subject only to the per-occurrence limit.

In fact, even if the policies were uncertain as to the proper method of allocation, a reasonable interpretation of the policies requires an “all sums” approach. And of course insurers have been in the position to protect themselves by drafting clear and explicit language that addresses how the obligation to perform should be measured where there is indivisible damage triggering their coverage. Compare Rochester German Ins. Co. v. Schmidt, 175 F. 720, 725-726 (4th Cir. 1909). Principles of insurance law, therefore, require that the interpretation of uncertain or ambiguous policy provisions favoring the insured must govern.

This contract-based approach to allocation also “solves” the question of horizontal versus vertical exhaustion: that is, where policies are triggered across time, must the insured collect first from all the primaries before tapping any excess coverage (and thus absorb cumulated deductibles and insolvent primary layers) or may the insured select a single year of coverage and access the triggered primary and overlying excess (either in a single year or in more than one). General-liability policies do not speak to this issue, and so we return to the principle that the contract rights belong to the insured; consequently, the insured has the option to select or target its triggered policies however it sees fit. In each instance, one asks the same questions: is the policy triggered, and if so how much does the policy pay per occurrence for the insured’s liability because of the (indivisible) damage/injury that year? Any targeted policy may seek to pursue equitable contribution against other carriers that could have been targeted but were not. Indeed, I submit that part of the peace of mind offered by broad CGL insurance is precisely the insured’s ability to collect its full per-occurrence limits and then go home – leaving further redistribution to the carriers to sort out.

This approach also gives the framework to address stacking or cumulation of policy limits, for looking at each contract the stacking or cumulation of policy limits again is straightforward. See United Services Automobile Ass’n v. Riley (Md. June 1, 2006). Until the insured is fully indemnified for its damages because of injury/damage during the policy year, the insured is entitled to collect on its coverage. In other words, stacking is only an issue if an insurer has clear anti-stacking language in its policy.

The bottom line of all of this is that policyholders should look hard at the contract without preconceived notions and see how each individual insurance contract’s obligation to perform is measured. Bearing in mind the crucial question of divisible versus indivisible harm and damage – and its impact on answering what is the insured’s liability for injury or damage during the policy period – insurance policies require insurers to perform if any “injury” occurred during the policy period and to pay their entire per-occurrence policy limit until such time as the insured has been fully indemnified or the insurance policy’s limits exhausted.

We confront the particular language of particular policies every time we settle a claim or file a complaint. Each contract should be analyzed using the toolkit I’ve sketched out here, and then you should move on to the next contract. Shampoo. Rinse. Repeat.

Posted by Marc Mayerson at 4:24 PM | Comments (4) | TrackBack
June 29, 2006
Equitas Financials -- 2006 Version

As part of the Reconstruction and Renewal of Lloyd’s in 1996, various participants in the Lloyd’s enterprise established several companies for the purpose of reinsuring the then-open syndicate years of account and managing the runoff of claims under those and prior years’ insurance policies. In 1997, the liabilities of a Lloyds’ owned-entity called Lioncover were reinsured into Equitas too.

Equitas issues an annual report and accompanying press release that discusses its results to date. Some of the highlights this year:

* Equitas’ retained surplus – that is, the amounts of its assets minus its expected liabilities – was reduced to £458 million.

* The retained surplus expressed as a percentage of net claims outstanding fell to 12 percent. In other words, Equitas expects its net claims to total roughly £3.8 billion. (p.6)

* Equitas paid £672 million in settlement of claims, including payment for 32 direct a*****estos claims and 15 direct pollution claims. (p.4, 7) In this context, this means payments in commutation of policy obligations. (Some of these payments likely were to policyholders with both a*****estos and pollution liabilities, and perhaps with more than one stream of liabilities, so one should not assume that Equitas did deals with 47 (32 + 15) different policyholders.) In the reporting period, Equitas completed more a*****estos-driven policy buyouts than in any previous year (p.6) In these a*****estos buyouts, Equitas is making payment on the assumption that Federal a*****estos-reform legislation is not passed, but if such legislation does pass it will receive a give back from the settling policyholders totaling £280 million. (p. 43)

* Even considering these settlements, Equitas increased its a*****estos reserves by £103 million, roughly the same amount that it increased reserves last year (£116 million), which makes up 53 percent of Equitas’s total reserves (with environmental and other health-hazards constituting another 24 percent of the reserves) (p. 41). The present value of the a*****estos reserves is £2.2 billion, with a nominal value of £3.4 billion (p.5). For the first time in seven years, Equitas increased its reserves for environmental liabilities too. Equitas assumes it will be making payments for these classes of claims for at least another 40 years (p.41). Further, Equitas assumes that the mean term of its liabilities, “that is the weighted average period to settlement where the weights are the undiscounted expected cash flows in each future period,” will be approximately 11 years, one year longer than the assumption made a year ago.

* Equitas continues its aggressive liquidation of its reinsurance asset, with an undiscounted asset of £700 million and a discounted value of £360 million (p. 7, 14). Reinsurers’ share of claims paid was reduced from last year from £209 million to £190 million, a reduction that is not surprising given the reduction in claims payment from Equitas and the dwindling value of the remaining reinsurance. One can express sympathy with Equitas for its problems in collecting from its reinsurers: “We see a growing trend for some reinsurers to dispute claims for no other reason than to demand discounts in the hope we will be afraid of the costs of collecting these balances.” (p.7)

* Equitas identifies the amount of “profit” it has made on settlements, profit in this context being the amount of reserves freed from a settlement at a figure less than the reserved amount. £435 million of Equitas’ surplus is acknowledged by it to be attributable to settlements it has made over the past four years at amounts less than the reserves it had previously established for the claims. Last year, settlements contributed £81 million to Equitas’s bottom line. (p.4) In other words, 95 percent (!) of Equitas’s net surplus is attributable to these reserving-freeing settlements.

* There are several related threads to follow to grasp the significance of this figure. When Equitas was established in 1996, it is known that the money it raised was reverse engineered based on predictions on what it could collect in settlements with brokers, managing agencies, and the reinsured names. The initial Equitas premium indication was widely viewed as being unacceptable to the individual participants at Lloyd’s, so the Equitas premium number was reduced to a level that the “names” would accept. When Equitas began operations in 1996, it had a “solvency” margin of 5.6%, meaning its then projections of liabilities were 5.6% less than its assets. In order to open for business, Equitas could not be insolvent the first day, so its reserves had to be reduced to allow it to (barely) show a solvency margin.

* Equitas has since hiked its reserves substantially, particularly for a*****estos. Reserve adjustments affect the year they are made (p. 35), so a settlement with policyholder X in 2003 that yielded a settlement profit of, e.g., $10 million should be recognized as yielding a settlement profit of a significantly greater amount if the associated reserves would have floated upwards with other reserve adjustments in subsequent years. So Equitas’s announcement of its settlement profit in the prior year understates the true profit amount, since the policyholder sold out its coverage for an even greater discount than it may have anticipated at the time of settlement.

* So, the reserve number for any given settling policyholder is likely to have been underestimated for either of two reasons: (i) all reserves were understated in the reverse engineering process to generate an acceptable Equitas “finality” premium and (ii) reserves subsequently have been adjusted upward either to compensate for that (conscious) underestimation or because then-unforeseen events yield higher valuations of the claim streams.

* Given that virtually all of Equitas’s solvency margin (and surplus) is attributable to policyholders’ settling out their coverage too cheaply, one can fairly say that the only thing keeping Equitas afloat is policyholders’ settling for too little (even from Equitas’s perspective).

* In this light, and perhaps in response to my constant harping on this issue (a theme I don’t see elsewhere), the CEO of Equitas offers the following defense of its claims-settlement practices:

“When we settle claims, whether those coming into us, or those we make on reinsurance policies, sometimes we pay or receive more than we had reserved, and other times less. . . . [S]ome deals were ‘winners’ (producing a contribution to surplus) while others were ‘losers’, but in the aggregate we achieved a win.” (p.4).

* I would challenge even the verity of the statement that some were ‘losers’ (for the reasons above) but at all events in the aggregate it is indisputable that Equitas’s effectiveness in snookering policyholders into settling for less than the reserve is Equitas’s margin.

* Given the tremendous success that Equitas has had in extinguishing major liabilities with its reinsureds’ direct policyholders (it has settled with all 10 of the largest direct a*****estos policyholders identified in 2001 (p.2)), Equitas has now turned its attention to its “inwards” reinsurance with US insurance companies. (p. 10) Since the time of the annual report, Equitas has achieved a major settlement with The Hartford (and which resulted in Hartford’s realizing less than its booked reinsurance receivable). So perhaps policyholders can take solace that they are in good company.

Notes: My commentary is available for Equitas Financials 2005 and 2004.

On March 31, 2006, 1 pound equaled $1.74.


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June 5, 2006
Discovery of Other-Insured Claim Files in Insurance and Bad-Faith Disputes

Among the typical skirmishes in insurance-coverage litigation is the scope of discovery. In seeking discovery in insurance-coverage cases and for insurance bad-faith claims, policyholders seek information from insurers about the underwriting of the policy at issue and the carrier’s handling of the policyholder’s claim for coverage. Disputes arise once the policyholder moves beyond those materials to information showing the general practice of the insurer, how the insurer’s response to the particular insured compares with how it has handled other claims, and the insurer’s own understanding of the policy language as evidenced through claims-handling manuals, training materials, and other types of interpretative aids. See generally Saldi v. Paul Revere Life Ins. Co., 224 F.R.D. 169 (E.D. Pa. 2004); Colonial Life v. Superior Court(Perry) 31 Cal. 3d 785 (1982); Carey-Canada v. Cal. Union Ins., 118 FRD 242 (D.D.C. 1986). One recurring subject has been other-claims information, that is, information in claim files dealing with other insureds.

Policyholders argue that such extrinsic evidence is both discoverable and potentially admissible. A recent case from the Federal Court in the District of Columbia had occasion to address the discoverability information from insurers that is stored electronically. In J.C. Associates v. Fidelity & Guarantee Ins. Co., 2006 WL 1445173 (D.D.C. May 25, 2006), Magistrate Judge John M. Facciola ordered the production of various “other claim” file information in the context of a dispute over application of the “absolute pollution exclusion.” In the earlier days of environmental coverage litigation, policyholders and insurers reached détente on production of the “ten and ten” – the ten oldest environmental claim files and the ten most recent. In this era of ediscovery, however, the J.S. Associates case looked more generally to information that was stored electronically.

In addressing the relevance of claim-file information in general, Magistrate Judge Facciola ruled:
[

T]he information plaintiff seeks is clearly relevant. For example, information as to how defendant interpreted the absolute pollution exclusion would qualify as an admission under Rule 801 of the Federal Rules of Evidence and relevant to the claim presented by plaintiff if that interpretation is different from the interpretation that the defendant is asserting in this case.

Id. at *1. The insurer had searched its computerized index of its 1.4 million claim files, which yielded 454 similar claims. The originals were not stored in electronic format, and the court considered the costs of manually reviewing the 454 claim files for relevant information as against the amount in controversy, $124,000. To balance the competing interests, the court required the insurer to scan the originals into a searchable format and directed it to search that population using the terms “1) pollution, 2) pollutant, 3) pesticide, and 4) insecticide.” Id.

For any of the 454 converted files that contained one of the search terms, the insurer was required to manually review the material for privilege. The insurer further was told to log the costs of the privilege review, but to count attorney time only for work “that requires an attorney’s skill and judgment.” Id. at *2. Citing the judge’s own prior decision in McPeek v. Ashcroft, 202 F.R.D. 31, 34 (D.D.C. 2001), the court reserved ruling on further discovery and the costs of any such discovery.

While the law is not uniform, the J.C. Associates decision is consistent with courts that recognize that extrinsic evidence from insurance companies may be offered to show (i) an ambiguity or uncertainty in policy terms, (ii) a coverage-promoting meaning when considered in context, or (iii) the reasonableness of the insured’s proffered construction. The evidence may also block a carrier from advocating a coverage-defeating construction in the particular case. Statements by the carrier may constitute admissions, as Judge Facciola found, or statements against interest. E.g., Gerrish Corp. v. Universal Ins. Co., 947 F.2d 1023 (2d Cir. 1991); Phoenix Ins. Col. v. Glens Falls Ins. Co., 253 F. Supp. 1014, 1019 (M.D. Fla. 1966) (state filings); Greer v. Northwestern Nat’l Ins. Co., 743 P.2d 1244 (Wash. 1987); Allegheny Airlines Inc. v. Forth Corp., 663 F.2d 751, 755 (7th Cir. 1981); Aetna Cas. & Sur. Co. v. Haas, 422 S.W.2d 316, 320 (Mo. 1968); Grinnell Mut. Reinsurance Co. v. Voeltz, 431 N.W.2d 783, 787-89 (Iowa 1988); Ford Motor Co. v. Northbrook Ins. Co., 838 F.2d 829, 833 (6th Cir. 1988).

More generally, “the interpretation given to the same contract by one of the parties in its dealings with third parties . . . has some weight – as demonstrating the past interpretation of at least one of the parties, and also suggesting the reasonableness of that interpretation.” Tymshare, Inc. v. Covell, 727 F.2d 1145, 1150 (D. C. Cir. 1984) (Scalia, J.).

The policyholder’s burden is to offer a construction of the policy language that is both linguistically permissible and reasonable. In discharging its burden of showing a reasonable construction, a policyholder’s proffering extrinsic evidence out of the mouths of insurer witnesses or from their pens or keyboards can be helpful. As one court stated in a related context, “[a]ny suggestion that an insured’s identical interpretation is unreasonable is absurd.” Montrose Chem. Corp. v. Admiral Ins. Co., 5 Cal. Rptr. 2d 358, 369 (Cal. App. 1992).

Often judges seem to take the position that they understand what a particular policy provision must mean when they see it. But that is not the relevant legal question; the task for the judge is not to pick the best construction or the one he or she thinks makes the most sense. Rather, the hermeneutical task is: what construction does the language admit and is the construction being offered a reasonable one? To this end, evidence from claim files and other materials from insurers sheds light – and thus is discoverable and potentially admissible on motions for summary judgment and at trial.

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May 17, 2006
Taming the Lion(cover): Lioncover, Lloyd's, Equitas, and the Central Fund(s)

W. Mark Felt or Hal Holbrook playing him said to "follow the money," which has proven difficult in the instance of Lloyd's of London, and a task made all the more important as a*****estos and environmental liabilities continue to fall upon corporate policyholders in the US that purchased broad insurance in the 1950s, 60s and 70s through the London market. While lawyers and policyholders may be familiar with Equitas, the reinsurance runoff and claims-handling vehicles set up in the late 1990s to deal with liabilities arising under historical Lloyd's policies, I have long believed that a key for litigators is something called Lioncover, a reinsurance vehicle originally set up to bailout important players at Lloyd's who were involved in Peter Cameron Webb "managed" syndicate years of account. Lioncover, which I understand to be a wholly owned subsidiary of the Corporation of Lloyd's and which houses the PCW business, initially was not reinsured into Equitas when Equitas was set up as part of the "Reconstruction and Renewal" of the Lloyd's operation. It was later poured into the Equitas structure but also is explicitly backed by the Lloyd's enterprise itself. Lioncover is a lever one can use to uncover the financial vehicles backing old Lloyd's policies (which contra to popular myth are not backed solely by the assets of Equitas or by the trust funds in the US). Lloyd's annual report for 2005 contains a few interesting crumbs worthy of note for Lloyd's/Equitas watchers.

First, Lioncover's liability payments in 2005 total slightly more than 525 million pounds or roughly $1 billion (US). These principally were attributable to a*****estos, environmental, and health-hazard claims. (p. 114; note 14)

Second, this amount is not reflected on Lloyd's net balance sheet because the directors of Lioncover conclude that, because Equitas says it will pay the claims, it can take that reinsurance recoverable as an offset on its balance sheet. (p. 120) As Lloyd's annual report states:

At present, ERL [Equitas Reinsurance Ltd.] and its subsidiary undertaking, Equitas Limited, which is responsible for the run-off of the reinsured business, continue to pay claims in full and the directors of ERL have stated that they believe that the assets should be sufficient to meet all liabilities in full. Accordingly, the directors of Lioncover have considered it appropriate to recognise the amounts recoverable from ERL in full. Should ERL ever cease to meet in full its obligations in respect of the PCW syndicates, Lioncover would be responsible to its policyholders for meeting any amounts remaining unpaid.

The establishment of Lioncover and its reinsurance into Equitas does not cutoff the policyholder's right to make claim under the policy as against the Lloyd's enterprise. (This is consistent with what I have been counseling that one should not look at Equitas' assets alone when evaluating whether to include a credit-risk discount in a deal done with Equitas.)

Third, in the event Equitas does fail to perform, then Lioncover may seek to obtain payment from the "Central Fund," which helps back the policies issued through Lloyd's. As part of the Reconstruction and Renewal process, there is an "old" Central Fund and a "new" Central Fund, and Lioncover can claim under both, though the Council of Lloyd's purports to have discretion not to pay under the new fund unless the current membership agrees. As the report explains:

Following the implementation of ‘Reconstruction and Renewal’, Names underwriting in respect of 1992 and prior years, Lioncover and Centrewrite were reinsured into Equitas. If Equitas were unable to discharge in full the liabilities which it has reinsured, any resulting shortfall in respect of Lioncover or Centrewrite could be met out of both the ‘Old’ Central Fund and the New Central Fund under the terms of their respective Lloyd’s bond. Both the ‘Old’ Central Fund and the New Central Fund would also be available to meet the claims of policyholders of Names who are party to hardship agreements executed before 4 September 1996, to the extent that such an event resulted in a shortfall. However, unless the members of the Society resolve in a general meeting to make the New Central Fund available, only the ‘Old’ Central Fund would be available to meet the claims of policyholders of Names who are not party to hardship agreements executed before 4 September 1996. The Council has determined that any losses resulting from such indemnities will be met by the Lloyd’s Central Fund. (p. 132, note 29)

There certainly is an open question whether there really is discretion not to pay under the new Central Fund, but the reason we care about this is that it is the current membership of Lloyd's that would be responsible for topping up the fund in the event of a shortfall (and that there would be a shortfall is a likely result if the new fund were tapped).

Note that simultaneously Lioncover's liabilities would need to be shown on Lloyd's balance sheet and the capital of the members would be hit, thus doubly impairing the financial ratings of the Lloyd's enterprise.

Fourth, my sense continues to be that, if Equitas stops making payments or determines that it has more mouths to feed than money (or owns up to that reality), following what happened with Lioncover and how it has been intermingled with "new" Lloyd's will be a key focus for discovery and trial when policyholders seek payment on their old Lloyd's policies and are shunted off to the admittedly penurious Equitas. The story of insiders being bailed out through Lioncover and new Lloyd's assumption of those liabilities and seeming manipulation of its own financial statements (by taking the reinsurance recoverable as a full, undiscounted offset while Equitas otherwise is proclaiming its own credit risk) will be the stuff of trial. The promises Lloyd's makes when selling policies are supposed to be backed up by the vaunted "chain of security," which means the assets of the current membership of the Lloyd's enterprise. Compare Industrial Guarantee Corp. v Lloyd's(1924) 19 Lloyd's List Law Reports 78 (Bailhache J).

The Lloyd's enterprise's efforts to "ringfence" the historic liabilities and to protect the current corporate members may yet prove successful -- at least to the extent that policyholderscooperate in obtaining less than the full value of their insurance; the chain of security will back the policies US companies purchased only once those companies bring litigation to force the Lloyd's enterprise to honor the promises made in the broad insurance policies sold to American companies (or in the unlikely event that regulators step in). Certainly, the halcyon days of Cuthbert Heath saying "pay all our policyholders in full" are long, long gone.

A somewhat expanded version of this commentary appears in 17 Mealey's Litigation Reports: Reinsurance (June 15, 2006).

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February 4, 2006
Fettering the Insurer’s Privilege to Control the Defense It Is Duty Bound to Provide

For more than fifty years, policyholders and their insurers have been struggling over the insurer’s promise to defend and the insurer’s control the defense. Policyholders properly have been concerned that an insurance company that controls the defense of an action potentially covered by the carrier’s duty to indemnify will use that control to avoid that very same indemnity obligation. While in egregious cases where a lawyer hired by the carrier has abused his or her relationship with the insured, the client, so as to favor the lawyer’s source of income – the insurance company – the courts have responded to protect the insured’s interests. But most courts have ruled that such after-the-fact remedies are insufficient: they do not adequately compensate for the injury; meritorious claims are not pursued (in part because insureds may not discover the abuse); and the potential for this abuse alone undermines the dominant purpose of the insurance relationship to afford protection and peace of mind for the insured.

As a result, most jurisdictions have fashioned a number of rules affording remedies in cases of actual abuse – by allowing bad-faith actions to proceed against insurers, by barring insurers from using the fruits of the poisonous tree, by allowing malpractice claims against the lawyer, and other measures. But most furthermore have held that where there is a situation of potential abuse a prophylactic approach is appropriate; thus the insured is permitted to select the lawyer to defend it and the carrier continues to have the obligation to pay for that defense. This is usually referred to as the "independent counsel" rule (or in California, the Cumis or 2860 rule).

Rarely do I see as a policyholder lawyer a insurance provision that expressly addresses this problem – something that is incomprehensible given that for more than two generations this struggle has been waged. Since at least the 1950s, the courts have made clear to insurers that, because their policies do not set out how these circumstances should be handled, the courts themselves will fashion rules designed to balance the interests of policyholders and their insurers. In general, the courts have looked to the dominant promise of the insurance contract to defend (and to indemnify) the insured and held that the correlative responsibility of the insurer to defend can yield to safeguarding that dominant purpose of the insurance contract. In part this stems from the contract drafting in which two words – “right and” -- in the insurance policy are what carriers rely on: they have the “right and duty to defend” (plus the insured’s duty to cooperate set out in the boilerplate portion of the policy).

Because insurers are well aware of the rule that uncertainties in the contract will be construed against them and the rule in the overwhelming majority of jurisdictions that their right to defend and its entailed privilege of selection and control of counsel has to yield to protect the benefit of the bargain the insured struck to obtain both defense and indemnity, the courts generally have held that insurers forfeit their privilege of control.

The paradigmatic circumstance where the insurer’s privilege of control yields to its duty to defend, to protecting the insured’s expectations of coverage, and to subordination to the insured’s interest is where a complaint alleges more than one claim arising out of a single event and the case can be lost on either a covered basis or an uncovered one. Take as an example where an during a pickup basketball game an elbow is thrown: if that occurred because of gross negligence, there will be coverage, but if it occurred because the player sought to intentionally injure the recipient, there won’t be. Trial of the case involves the same facts and testimony either way, and ultimately it’s up to the jury to weigh the testimony and the facts. The insurer if it is to lose the case would prefer to lose it on intentional-injury grounds, for then it won’t have to pay the judgment.

Another example: assume there is a technical defense available to the covered claim; should the lawyer file a motion for summary judgment on the covered claim, which will effectively pretermit the carrier’s ongoing obligation to defend (since the case no longer can eventuate in a judgment covered by the duty to indemnify)? Does the lawyer have an obligation to leave the weak claim hanging around just to preserve the defense or does the lawyer – whose bills are being paid by the insurer – have the obligation to clean out the dross and thus allow the carrier off the hook?

Insurers have pooh-poohed such concerns by contending that lawyers act ethically so the courts’ concerns are unfounded. And the United States Court of Appeals for the Fourth Circuit – a court that has a penchant for mispredicting state insurance law by siding with insurance companies – recently agreed with the insurers in what should become carrier-side lawyers’ favorite case to cite on these issues. In a well-written, well-analyzed, but erroneous ruling, Twin City Fire Ins. Co. v. Ben Arnold-Sunbelt Beverage Co. (4th Cir. Dec. 27, 2005), the Fourth Circuit rejected the argument that an insurer’s reservation of the right to deny coverage called for prophylactic protection of the interest of the insured by allowing it to select counsel of it choice to defend at the insurer’s expense.

Of course, Ben Arnold involves reasonably favorable set of facts for carriers and overbroad argument by the policyholder, but the court’s ruling is not so confined. The court sets up the question presented as follows:

When a party with insurance coverage is sued, the insured notifies the insurance company of the suit. The insurance company, in turn,typically chooses, retains, and pays private counsel to represent the insured as to all claims. If the suit involves some claims that are covered under the insurance policy and some claims that are not covered, the insurance company typically will send a reservation of rights letter to the insured stating what claims the insurance company believes are covered and what claims it believes are not covered. In this case, we examine whether, under South Carolina law, such a reservation of rights letter automatically triggers a conflict of interest entitling the insured to reject counsel tendered by the insurance company and instead to choose and retain its own counsel and to have the insurance company pay for that counsel.

Slip op. at 1. The proposition offered by the insured was that any time an insurer issues a reservation-of-rights letter it is still required to provide a defense but the policyholder gets to select counsel to defend it and control the course of the defense.

The Fourth Circuit rejected the policyholder’s argument, noting correctly that courts tend to require that the insured show there to be a conflict of interest between it and the insurance company before wresting the defense from the carrier. This is sensible, of course, given that in the insurance policy the policyholder delegated to the insurance company the right to defend the case. Insurance companies issue reservation-of-rights letters in response to case law in the 1950s and 1960s that a carrier that defends a suit cannot turn around at the end of the case and tell the insured that it won’t pay for the judgment – at least without alerting the insured of this possibility earlier; as a result, insurance companies issue reservations of rights to prevent the insured from having detrimental reliance (or claiming waiver). National Mut. Ins. Co. v. McMahon & Sons, 356 S.E. 2d 488, 493 (W. Va. 1987); Safeco Ins. Co. v. Elllingshouse, 725 P.2d 217, 221 (Mont. 1986); Richmond v. Georgia Farm Bureau Mut. Ins. Co., 231 S.E.2d 245 (Ga. 1976); Royal Ins. Co. v. Process Design Associates, 582 N.E.2d 1234, 1239 (1st Dist. 1991).

But it is not the insurance company’s fault that a suit may involve both covered and uncovered amounts, and coverage is not to be expanded beyond the terms of the policy through application of principles of waiver. As a result, it is entirely appropriate for an insurance company that is contractually obligated to provide a defense to a policyholder to alert it to the possibility that the judgment in the case might not be covered. D.E.M. v. Allickson (North Star Mut. Ins. Co.), 555 N.W.2d 596 (N.D. 1996). In this way, the policyholder can act to protect its own interest, including in some states choosing to settle the lawsuit against it in a fashion that camouflages whether the payment is also on account of uncovered amounts or claims. See generally Miller v. Shugart, 316 N.W.2d 729 (Minn. 1982).

So, unless some other interest or question is involved, the mere fact that an insurer sends a reservation-of-rights letter should not alter the parties’ preexisting rights and powers (since all the insurer is trying to do is to avoid waiver/estoppel from its assuming the defense).

Against this background, the Fourth Circuit rejected the notion that a reservation-of-rights letter per se creates some sort of conflict between the interests of the insured and its insurer such that the insurer is divested of its contractually bargained-for right to defend. But the court went on to recognize that there are circumstances where the interest of the insured and the insurer in the development of the defense can diverge, which has led most courts to express concern about insurer-appointed and insurer-directed counsel.

The Ben Arnold court reviews the law in a number of jurisdictions (having found that South Carolina law applies and was without governing precedent) and concludes that some courts allow the insured to select counsel paid contemporaneously by the insurer whereas other courts permit the insurer to select “independent” counsel who in turn may have heightened professional duties to safeguard the insured’s interest. Because a strong undercurrent in those cases vesting the choice of counsel in the hands of the insured questions the ethical integrity of the insurance-defense bar, e.g., Howard v. Russell Stover Candies, Inc., 649 F.2d 620, 625 (8th Cir. 1981) (requiring independent counsel for fear that counsel for insurer “would be inclined, albeit acting in good faith, to bend his efforts, however unconsciously” in insurer’s favor), the Fourth Circuit was highly reluctant to impugn with such a broad brush the integrity of an entire swath of the bar. Slip op. at 11 (“We are equally unable to conclude that the Supreme Court of South Carolina would profess so little confidence in the integrity of the members of the South Carolina Bar. Rigorous ethical standards govern South Carolina attorneys.”).

The Fourth Circuit concluded that the ethical rules and discipline, “coupled with the threat of bad faith actions or malpractice actions if a lawyer violates these rules, provide strong external incentives for attorneys to comply with their ethical obligations.” Slip op. at 12. Accordingly, the Ben Arnold court refused to find that, where there was a conflict of interest between the insured and the insurer in the development of the facts at issue in the liability case, the insured had a right to counsel of its choice, paid for contemporaneously by the insurer.

The court furthermore adopted a strict forfeiture rule in this regard, finding that if an insured rejected counsel tendered by an insurance company it forfeits the right to defense coverage. In other words, the policyholder is precluded from seeking coverage even if the insurance company cannot show that it was in any way was harmed by the policyholder’s selection of counsel (e.g., competent counsel at the same rate, for example, who obtains an outstanding result). The court rejected the policyholder’s contention that the insurers must show substantial injury or prejudice or at least some detriment in order to be excused from providing the policyholder any of the benefit of the bargain. Slip op. at 13-15.

Ben Arnold is sure to be relied on by insurance companies as a cogent statement of their position in favor of rejecting the policyholder’s selection of counsel of its choice. Nevertheless, the court need not have reached out to proclaim its own, pro-insurer prophylactic rule because the facts of the case and the conduct of the insurers at issue merit no such prolegomenon.

In Ben Arnold, the insurers retained qualified counsel to defend the covered counts and in addition offered to pay for separate counsel to represent the insured’s interests with respect to uncovered counts. Moreover, with respect to a different insured in the case where there was a conflict of interest in the development of the facts, both the trial court and the Fourth Circuit found that independent counsel was required to be appointed at the carriers’ expense. And even with respect to the principal insured for which there was no conflict at issue in the development of the underlying facts, the trial court recognized that at the time of settlement independent counsel might be required due to the conflict that then would be manifest. 2004 WL 2165971 (D.S.C. July 26, 2004), at n. 14.

What is lamentable about the Fourth Circuit’s opinion is that the court could easily and more properly have held that, given the absence of a conflict of interest between the insured and insurer in the development of the underlying facts, independent counsel was not required and in any event the insurers satisfied their obligations by offering to pay for two sets of counsel. This is the rule in “independent counsel” states where most courts recognize that merely sending a reservation-of-rights letter – without more – is insufficient to oust the insurer of the control of the defense. National Union Fire Ins. Co. v. Hilton Hotels Corp., 1991 WL 405182 (N.D. Cal. 1991). In fact, wresting control whenever a reservation of rights is sent ironically defeats the purpose for why such reservations were sent in the first place.

But Ben Arnold should not be rejected just because it is overly broad, for even were the facts to match the very broad rule adopted that rule still would be ill advised and erroneous under principles both of insurance law and of contract law. Perhaps because the issue has been in dispute for so long (half-a-century), the footings of the independent-counsel rule seem to have become beclouded.

Let’s look first at the consequences of the Ben Arnold court position. The court makes clear that, while there might a perception of discomfort by the policyholder in the carrier’s selected lawyer being in charge (and thus having the ability to steer the defense toward uncovered grounds), the insured’s interest is adequately protected because of legal-ethics rules, attorney-malpractice liability, and insurance bad-faith principles. This rejoinder to the policyholder position really does not withstand scrutiny.

The Fourth Circuit’s remedies render nugatory the peace of mind and security the insured is supposed to receive by paying a premium to the insurance company for the broad protection afforded by insurance policies. See Rawlings v. Apodaca, 151 Ariz. 149, 154-55 (1986) (“Although the insured is not without remedies if he disagrees with the insurer, the very invocation of those remedies detracts significantly from the protection or security which was the objection of the transaction.”). The court envisions requiring policyholders to endure bad faith or ethical breaches, and then seeking recovery only at the end of the underlying litigation by suing for legal malpractice or bad faith. Ben Arnold thus replaces the security that insurance is supposed to provide with a chose in action against the insurer-appointed lawyer, requiring the policyholder to (a) sue for legal malpractice, requiring a showing both of breach of the standard of care and a showing that the outcome would have been different (the “trial within the trial” of such malpractice actions), (b) undertake that action at its own expense (since the insurer is not paying, and there’s no attorneys’ fees recovery in malpractice cases), (c) in the meantime front the money for the adverse judgment in excess of policy limits or even the entire judgment if it is based on an uncovered claim (and subsequently, if successful, refund to the carrier in subrogation any amounts recovered after the policyholder was made whole), and (d) expose itself to an uncollectible judgment because the lawyer may not have assets sufficient to cover the judgment that resulted from his malpractice.

The Ben Arnold solution to the conundrum of insurer-appointed counsel further would do substantial injury to the attorney-client relationship; not only would the insured find it difficult to confide in counsel assigned to it, but counsel’s effectiveness would be undermined by its knowledge that the carrier has set it up for an impending malpractice action. And the same problems apply regarding suing the carrier for bad faith for some misconduct of the insurer-appointed lawyer or suing for negligent performance of the duty to defend by providing inadequate counsel.

The proposed remedy that the Ben Arnold court contemplates is a feeble substitution for the security and protection that the policyholder thought it was paying for. And if one looks at the cases decided forty or fifty years ago, these courts found it salient that the insurers’ policies did not spell out how this conflict situation would be handled. Standard insurance policies then (as now) were not written to state plainly and unambiguously that (i) interference with the right to defend forfeits coverage or (ii) the right to defend constitutes a material part of the consideration of the overall insurance transaction (which would be an overreach anyway given the aleatory nature of insurance contracts, that is, that the policyholder has fully performed its principal obligation of paying the premium).

Thus, the courts have applied the ordinary rules that where the policy language was uncertain and the insurer was in a position to clarify by drafting a provision clearly, the policy is construed in favor of coverage to achieve its purpose of indemnifying the insured, especially bearing in mind the reasonable expectations of insureds and avoiding the appearance of unseemliness from insurer-appointed counsel’s being in the position to steer the case to favor his or her source of future business. E.g., Employers' Fire Ins. Co. v. Beals, 240 A.2d 397, 402 (R.I. 1968); Magoun v. Liberty Mut. Ins. Co., 195 N.E.2d 514 (Mass. 1964); Prashker v. United States Guarantee Co., 136 N.E.2d 871 (N.Y. 1956); see also CHI of Alaska, Inc. v. Employers Reinsurance Corp., 844 P.2d 1113, 1116 (Alaska 1993). As a result, most courts ruled that the carriers’ right to control the defense – an ancillary part of the insurance contract – must yield to the predominate purpose of the contract to provide the policyholder a defense and to safeguard the policyholder’s peace of mind. See Jacobs & Youngs, Inc., 129 N.E. 889, 891 (N.Y. 1921) (Cardozo, J.) (“There will be no assumption of a purpose to visit venial faults with oppressive retribution.”). That carriers have not fixed their policy language after 50 years of litigation and instead require that the law be developed in each state and locality smacks of ineptitude or bad faith or some synergistic combination of the two.

Nevertheless, one dissembling rejoinder to this would be to contemplate a situation where the policyholder does erroneously reject the carrier’s offered defense (which approximates the actual facts in Ben Arnold). In that circumstance, so the argument goes, if the carrier remains responsible for funding the defense, the carrier that offers to perform properly is no better off than is the carrier that breaches its contract by refusing to provide a defense at all. In other words, a carrier that breaches its duty to defend by erroneously denying coverage is liable to pay the reasonable costs of defense; and according to this argument a carrier that offers counsel that is rejected by the policyholder is still obligated to pay the reasonable costs of defense.

This is a false counter, because it misstates the damages that are to be paid by a breaching carrier (that is, the contract-law damages it owes for breach of the duty to defend). It is not precise to say that a breaching insurer owes the reasonable costs of defense; rather, under Hadley v. Baxendale, the insurer owes all foreseeable damages. In the circumstances, the policyholder proffers in its prima facie case all defense costs it incurred (that were caused in fact by the carrier’s failure to perform), and the carrier may argue by way of affirmative defense (and for which it has the burden of proof) that the costs were so unreasonable as to constitute unforeseeable damages ( which when framed correctly is a difficult standard for the carrier to meet, especially in the light of the fact that the insured had every economic incentive to incur only reasonable costs since, at the time, it was paying them out of its own pocket with no certainty of recovery from the carrier). Moreover, a breaching carrier is not just liable for defense costs, it is liable for all damages incurred by the insured from the breach. Beck v. Farmers Insurance Exchange, 701 P.2d 795, 801 (Utah 1985).

Contrast this situation to that of the carrier that does offer a defense but which is rejected by the policyholder on the ground that independent counsel is required – though in this illustration the policyholder is wrong to do that. In that circumstance, the concepts of material versus immaterial breach are key (as are dependent versus independent covenants). Here, the carrier has not breached, but the policyholder has. But the policyholder’s breach – by interfering with the carrier’s right of control – exposes the policyholder to the carrier’s set-off claim because it is an immaterial breach of the overall contract. In other words, the carrier is still required to perform its contract – for the policyholder’s breach is not a material breach of the contract excusing the carrier’s obligation (especially when the policyholder has probably already paid the full premium). See generally Steakhouse, Inc. v. Barnett, 65 So.2d 736, 738 (Fla.1953)(defining dependent covenants). But because the policyholder did breach the contract, the carrier is entitled to show its damages from the policyholder’s breach. In this context, what that means is the additional cost of the defense that would not have been incurred had the policyholder not breached (i.e., not been in charged). So, if the defense counsel the insurer would have appointed charged only $300 an hour (because of say a bulk deal with the carrier) and the policyholder’s selected lawyer charges $400 an hour, the carrier is not obligated to pay the $100 an hour difference. (Unlike Ben Arnold where the carriers' to their mirth owe nothing.) Importantly, this is in contrast to the breaching carrier which is unlikely to be able to show that the $100 an hour delta is such an unreasonable cost differential as to constitute unforeseeable damages under Hadley v. Baxendale. Moreover, the carrier that properly offered counsel is not exposed to paying the insured’s full damages (sometimes pejoratively characterized as “consequential damages” (Machan v. Unum Provident Ins. Co., 2005 UT 37 (Utah June 17, 2005)), because it did not breach.

Thus, a carrier that properly tenders performance that is incorrectly rejected is not in the same (disadvantaged) position as is a carrier that breaches its contract. Accordingly, under this analysis, everyone is put in the position they would be in had the contract been properly performed – the benefit of the bargain is preserved.

Until such time, therefore, that insurers revise their contracts to specify that even in a conflict of interest situation the insurer still gets to appoint counsel (or whatever method it would propose, such as allowing the insured to pick from a list of five counsel suggested by the insurer), the uncertainty of the contract, and the disproportionality of the proposed remedy contemplated by the Ben Arnold court, confirms the rightness of the independent-counsel rule. See generally Restatement (2d) Contracts Sections 197, 229 (2004). If insurers do revise their contacts, then (i) insurance regulators would be in the position to weigh in, (ii) policyholders would know expressly what the process is for dealing with a conflict situation if it purchases the particular insurance policy, and (iii) policyholders could choose to purchase policies from other insurers that offer more generous terms. But it is folly to believe that policyholders contemplate the remedial scheme adopted by the Ben Arnold court. See Restatement (2d) Contracts Section 211(3).

Note: A version of this commentary was published in 5 Insurance Coverage Law Bulletin (May 2006) at 1

Posted by Marc Mayerson at 11:39 PM | Comments (0) | TrackBack
January 16, 2006
Gelding the Pollution Exclusion: Welding Exposure Claims Not Barred

For the past several years, the plaintiffs’ tort bar has sought to make workplace-exposure claims by welders the proverbial “next a*****estos.” These cases typically allege a Parkinson’s Disease-like syndrome (“Parkinsonism”) or other neurological impairments (all generally referred to as “manganism”) allegedly stemming from the welder’s exposure to manganese while working. Whether this is a mass-tort with legs is certainly not clear, and the defense has had successes (even in what are considered to be plaintiff-friendly jurisdictions). Naturally, this litigation has produced insurance cases too, and the Maryland Court of Appeals (its highest court) recently ruled that an absolute pollution exclusion did not apply to bar coverage. Clendenin Bros. v. United States Fire Ins. Co. (Md. Jan. 6, 2006).


The Clendenin decision is significant in part because it disagrees with a prior Fourth Circuit decision, National Electrical Manufacturers Association (NEMA) v. Gulf Underwriters Insurance Company, 162 F.3d 821 (4th Cir. 1998). The NEMA case found that a pollution exclusion applied to the bodily injury claimed in the welding-rod litigation. The Maryland high court disagreed. (The Fourth Circuit is a bit of a recidivist in this regard, inaccurately predicating that state law would rule for insurance companies only to have the state later expressly go the other way. Compare Mraz v. Canadian Universal Insurance Company, 804 F.2d 1325 (4th Cir. 1986) (holding that Maryland law mandated a “manifestation” trigger of coverage) with Harford County v. Harford Mutual Insurance Co., 610 A.2d 286 (Md. 1992) and compare Maryland Casualty Co. v. Armco Co., Inc., 822 F.2d 1348, 1352-54 (4th Cir. 1987) (predicting that Maryland would refuse to recognize CERCLA response costs as “damages” under CGL policies) with Bausch & Lomb, Inc. v. Utica Mut. Ins. Co., 625 A.2d 1021, 1032-33 (Md. 1993).)

The Maryland court recognized that the substance at issue had a useful purpose and only allegedly was harmful where a person was exposed to undue levels. As the court ruled: “Therefore, reading this definitional provision as a whole, we conclude that to qualify as a pollutant under the contractual definition the substance must be understood to be an irritant or contaminant.” (Slip op. at 13) The court distinguished prior authority (where the insured had conceded that carbon monoxide was a contaminant) on the basis that the manganese might or might not be considered a pollutant depending on the circumstances. (Id. at 14) This should strongly counsel to policyholders that they need (in good faith) to dispute in the liability case, and certainly in the coverage case, that the substance to which the plaintiff was exposed is malum in se.

The court further embraced the standard creation-story of the absolute pollution exclusion to confirm that its linguistic, contextual construction allowing for coverage was not inconsistent with the policy intent. (Slip op. 18-20; slip op at 21 (“We conclude also that the current construction of the total pollution exclusion clause drafted by Insurer was not intended to bar coverage where Insureds ' alleged liability may be caused by non-environmental, localized workplace fumes.”).

And the court confirmed that this type of product-liability risk – though it takes the form of contamination of exposed persons – is reasonably thought to be comprehended by the product-liability insurance provided by CGL policies. As the Maryland high court explained: “Welding fumes emitted during the normal course of business appear to be the type of harm intended to be included under coverage for routine commercial hazards.” (Slip op. at 19). Indeed, the court expressed its overall rationale more broadly and powerfully: “The specific language used in the total pollution exclusion clause, when read in its entirety, supports the conclusion that noxious workplace fumes were not intended to be excluded.” (Slip op. at 20)

Well aware of the continuing litigation over application of the absolute pollution exclusion to workplace- and product-exposure claims, the court recognized: “We expect that, our decision notwithstanding, interpretation of the scope of pollution exclusion clauses likely will continue to be ardently litigated throughout state and federal courts.” (Slip op at 21).

Posted by Marc Mayerson at 3:55 PM | Comments (0) | TrackBack
October 11, 2005
Kentucky Rules on Environmental Coverage

Many of us who have been practicing for quite some while in the insurance-coverage area at times marvel at the return or continuation of the coverage "wars" of the 1980s. We still confront the same issues in cases that were the focus twenty years ago, though sometimes courts confront new twists in otherwise well-trodden paths.

The Kentucky Supreme Court recently had the opportunity to address a number of the key environmental coverage issues in an insurance dispute commenced in 1987. In an opinion challenged by a lengthy dissent, the Kentucky high court addressed (among others): (i) whether response costs represent covered “damages” on account of property damage indemnifiable by CGL policies; (ii) whether administrative enforcement proceedings were “suits” to which the duty to defend applied; and (iii) how the (equivalent of an) owned-property exclusion applies. It also addressed whether the insured knew of the risk of injury such that coverage should be denied. And the court addressed whether the insurers’ payment of damages for breach of the duty to defend was subject to policy limits, which would have been the case had the insurers performed initially. This last issue, especially as resolved by the Kentucky high court, is not typical fodder in environmental-coverage cases.

In Aenta Cas. & Sur. Co. v. Commonwealth, (Ky. Sept. 22, 2005), the Kentucky Supreme Court held that coverage applies to “any claim asserted against the insured arising out of property damage, which requires the expenditure of money, regardless of whether the claim can be characterized as legal or equitable in nature.” Slip op. at 13. The ordinary meaning of “damages” to which CGL-type policies apply includes response or cleanup costs “as long as the purpose is to rectify, correct, control, lessen or stop ongoing injury of the premises.” Id. The court further ruled that measures undertaken onsite (that is, at the insured’s own property) were covered “when the primary intent is to prevent additional harm to the property of others or to public waters.” Id. at 16.

The court likewise rejected the insurers’ argument that the word “suit” can refer only to actions in court. Instead, the court found that “the term ‘suit’ is susceptible of more than one interpretation.” Id. at 10. In finding a duty to defend, the Kentucky court recognized that the power of the environmental authorities to pursue matters in court or in an administrative proceeding should not result in coverage being afforded in one instance and not the other, ruling that the insurers were “clinging to an archaic definition of ‘suit.’” Id. at 11.

Turning to whether the insureds had acted with so much knowledge of the risk of loss that coverage should be denied, the Court reversed the jury verdict denying coverage on this point, finding fatal error in the instructions. More specifically, the court held that the insureds were “entitled to insurance coverage unless they specifically and subjectively intended to cause the migration of radioactive contamination.” Id. at 9.

All of the foregoing is essentially consistent with the majority law of the land. The court addressed another matter that caused the author of the dissenting opinion to charge that the majority’s ruling constituted “the exercise of arbitrary power” in violation of Section 2 of the Kentucky Constitution. Dissenting Opinion of Justice Cooper, slip op. at 32. The factual context is that defense costs paid under the policy applied against policy limits. As the policy states: “Each payment made by the companies in discharge of their obligations under this policies . . . shall reduce by the amount of such payment the limit of the companies’ liability under this policy.” Slip op. at 17.

The majority reasoned that this limitation on coverage – that is, counting defense costs within limits – applied only to “voluntary payments by the companies in furtherance of the contractual obligations under the policy . . . . .[It does not] include payment of damages under compulsion.” Id. at 18. In other words, the court found that a condition of the carriers’ ability to count the defense costs toward policy limits was their voluntarily making payment; as a result of their breach, the protection of the provision was not available to them.

The dissent took a different tack on this point, by arguing that the purpose of breach-of-contract damages was simply to place the insured in the same position it would have been in had the carrier performed as contractually required. Framing the issue this way, the dissent found that allowing recovery to the insured without offset against the policy limits was a windfall.

The dissent reflects the general instinct that contract damages should place the insured in the same position it would have other been in had performance been rendered. But that principle is misunderstood often to mean that damages are in effect substitute performance, i.e., if a contract to pay $100 is breached, the damages are $100. That conclusion, however, is too facile. At a minimum, the $100 = $100 does not account for the timing of performance – that is, that I was supposed to have received my $100 when the other side’s obligation to perform was mature. The point of contract damages is to compensate me for not receiving my $100 when it was owed, which at a minimum requires that the time value of money be accounted for (that is, interest on the principal amount should be paid). (In insurance, the policyholder also has lost the benefit of peace-of-mind protection, assistance in the time of need.) But my damages from not having the $100 at the time I should have received it could be more – maybe, I lost my house because I couldn’t make mortgage payments. That type of claim sometimes is derided as “consequential” damages, but that’s not the right way to look at it (because that largely assumes the conclusion). The questions for calculating contract damages are: (i) were those damages factually caused; (ii) are those damages not foreseeable within the meaning of Hadley v. Baxendale; and (iii) are they capable of being reasonably estimated. One of the more thoughtful cases on insurance contract damages is the Utah Supreme Court’s decision, Beck v. Framers Ins. Exch., 701 P.2d 795 (Utah 1985).

Moreover, the damages owed for breach of contract are not capped by the policy limits – where the contract-performance owed and the factually caused foreseeable damages exceed the policy limits. The policy limit is relevant to the insured’s expectation damages. But it does not resolve the question of the amount of damages that are proper to be awarded. One cannot turn around in the face of factually caused foreseeable damages that exceed policy limits and assert an affirmative defense that the additional amounts are not owed due to policy limits. The policy-limits cap is available where a carrier performs, not where it breaches.

The majority is surely right to consider the impact of the policy provision that as the court reads it counts defense costs toward policy limits only where the carrier voluntarily performs. Just as waivers of consequential damages clauses will be enforced (if clear, voluntarily entered, etc.), so too the provision here limiting the insurer’s obligations to pay should be treated similarly to other exculpatory clauses. Here, the carriers sought to limit their obligation to pay defense costs when they assumed the defense voluntarily.

That the provision does not apply to breaches creates a bit of a conundrum because, as the dissent points out, the expectation was not that defense would be paid in addition to policy limits. But in the absence of a policy provision that applied by its terms and given that the carriers were the breaching party seeking to cabin their damages obligation, the carriers lacked a valid basis to limit the damages to be awarded. Once the court interpreted the provision by its terms to apply only where the insurers voluntarily assumed the defense, then no other result really seems possible.

Posted by Marc Mayerson at 2:24 PM | Comments (0) | TrackBack
September 11, 2005
Absolute Nonsense

What we once conceived of as the environmental coverage wars continue in a new, broader form where insurance companies seek to deny coverage for the liabilities of their policyholders whenever they stem from toxic exposures.

In 1986, the “absolute” pollution exclusion was widely introduced. There is agreement that Superfund-type claims and other true environmental liability claims are barred under the various guises of the absolute pollution exclusion. But the insurers have not limited their claim denials to that context.

The question of the proper scope of the absolute pollution exclusion typically is characterized as whether it applies only to “traditional” environmental claims or whether it applies to any toxic-exposure case. Disputes have proliferated, with the main groups of disputes concerning: (i) worker-exposure claims where a worker is, for example, doused with a toxic substance or exposed to toxic fumes; (ii) product-liability claims where the injury produced by a defect in a product involves the exposure to toxic substances; and (iii) landlord-tenant and similar premises claims where a tenant is exposed to fumes through the negligent act of the landlord or of a contractor it hired.

The New Jersey and Washington State Supreme Courts have reached conflicting results on this question this year. Nav-Its, Inc. v. Selective Insurance Company of America (N.J. April 7, 2005); The Quadrant Corporation, et al., v. American States Ins. (Wash. April. 28, 2005) The New Jersey Court, like the Washington Court, recognized that “read literally, the exclusion would require its application to all instances of injury or damage to persons or property caused by . . . any solid, liquid, gaseous, or thermal irritant or contaminant.” (Slip op. at 19) But the court rejected this construction saying that it would be “overly broad, unfair, and contrary to the objectively reasonable expectations of the . . . regulatory authorities” who approved it. (id. at 20). The New Jersey court found that when presented for approval the insurance industry did not say that the exclusion would bar coverage for toxic exposures but rather characterized it as a pollution exclusion, and applying its former ruling on the sudden-and-accidental exclusion the New Jersey court confined the reach of the absolute pollution exclusion to pollution activities. (The New Jersey approach is sometimes called “regulatory estoppel” but it is really a form of “estoppel in pais” and its variants such as Cal. Evid. 623.)

Seemingly mindful of its reputation with insurers as a court that runs roughshod over policy language (or, more charitably, negates the application of policy terms without quite finishing the intellectual edifice to support the result, e.g., Spaulding Composites v. Aetna Cas. & Sur. Co., 819 A.2d 410 (NJ 2003), the New Jersey Supreme Court ended its unanimous opinion stating:

As a final observation, the insurance industry has revised its policies in the past to provide for the exclusion of certain coverages. We will review each change on the record presented. We emphasize that industry-wide determinations to restrict coverage of risks, particularly those that affect the public interest, such as the risk of damage from pollution, environmental or otherwise, must be fully and unambiguously disclosed to regulators and the public.

(Slip op. at 25)

In justifying its holding, the New Jersey court sought comfort in numbers and cited a number of other courts that similarly confined the application of the exclusion to “traditional” environmental claims. One of those jurisdictions it relied on was Washington State, whose highest court ironically held three weeks later that an absolute pollution exclusion was not limited in this manner.

Both the New Jersey and the Washington cases involved remarkably similar facts: tenants who inhaled fumes from chemical sealants and claimed various ailments as a result. While recognizing the split in the case law, the Washington court’s nose-counting exercise convinced it that “a majority of courts have concluded that absolute pollution exclusions unambiguously exclude coverage for damages caused by the release of toxic fumes.”

The key to the Washington court’s rationale was the manner in which it sought to distinguish its own prior authority where the absolute pollution exclusion was held not to apply to the claim by a worker who was doused with gasoline. Essentially, in Quandrant the court holds that if one breathes fumes the pollution exclusion does apply but if one bathes in the source it does not apply.

The court further posits that the reasonable expectation of an insured would naturally be that the policy would not respond to a fume case caused by the negligence of a third party. And while the court assiduously claims to be applying the plain meaning of the exclusion, it never once comes to grips with the fact that the exclusion is for “pollution.” In other words, the court would be on stronger ground in my opinion were the exclusion simply to apply to the discharge, release, etc. of any irritant or contaminant – but the exclusion bars coverage for liability due to “pollution,” which in turn is defined to include irritants and contaminants. A reasonable insured may be charged with understanding the titles of the various exclusions (though the terms govern), but it is absurd to posit that the title indicating a limited context – pollution – is irrelevant to hypothesizing what a reasonable insured would understand. Compare Tektrol Ltd. v. International Ins. Co., [2005] EWCA Civ. 845 at para. 22 (July 21, 2005) (Opinion of Sir Martin Nourse) (''Loss' is a word whose meaning varies widely with the context in which it is used. If a man said to you: 'I have lost my wife', you would understand him to mean one thing outside the maze at Hampton Court and another outside an undertakers in the high street.").

The landlord is being held liable on straightforward premises liability (there being no suggestion of the landlord’s contributory negligence or negligent supervision or hiring); the landlord’s conduct in the circumstances is no different from where a painter negligently spilled paint on a tenant passing by. (Under the Washington decision, that claim would be covered, but if the passerby inhaled the latex in the paint that would be excluded as a polluting event.)

Posted by Marc Mayerson at 3:58 PM | Comments (1)
August 30, 2005
Grab Your Umbrella -- and Magnifying Glass

For the past two decades, policyholders and insurers have been fighting over whether the cost of cleaning up hazardous-waste sites is covered under general-liability policies by arguing over the nature of that liability. The argument has tended to center on the meaning of the word "damages" and the insuring agreement's promise to afford indemnification for the sums payable "as damages."

Departing somewhat from the standard version of these arguments, the California Supreme Court ruled in 2001 that covered "damages" were limited to amounts awarded by a court. Now, the court has reaffirmed that holding, County of San Diego v. Ace Property & Casualty Ins. Co. (Cal. Aug. 29, 2005), but in a companion case held that an umbrella policy that afforded coverage for "expenses" in addition to "damages" unambiguously applied to clean-up costs incurred in an administrative proceeding. Powerine Oil Co. v. Superior Court (Cal. Aug. 29, 2005). The court purports to be implementing the "mutual intent" of the parties, with the result that one insured has coverage due to the inclusion of the word "expenses" and the other one does not.

It is true that the purpose of umbrella policies is to provide broader coverage than the underlying coverage and to drop down or step down and fill in any gap created by a loss that is not covered by the underlying insurance. We generally conceive of this gap- filling function as ensuring that the policyholder does not fall between two stools, when for example neither an auto policy nor a homeowners' policy applies to some strange loss involving an automobile. Nothing in the language of umbrella policies limits their coverage to these types of gaps, and the California Supreme Court apparently had no trouble at all concluding that indemnification for expenses naturally includes clean-up costs in state administrative actions, even though the underlying coverage -- which indemnifies "only" for "damages" -- does not apply. As the Powerine court explained, "We therefore conclude that under a literal reading of Central National's excess/umbrella policies, the indemnification obligation is expressly extended beyond court-ordered money 'damages' to include expenses incurred in responding to government agency orders administratively imposed outside the context of a government lawsuit to cleanup and abate environmental pollution." (Slip op. at 23)

But this was not the result for the County of San Diego, because though its policies used the term "expenses" in the "ultimate net loss" provision (thus making clear the policy indemnifies for "expenses" and indicating how the policy limits were to apply), the word "expenses" was located in the wrong place as far as the Calfornia court was concerned. As the court explained [sic] in italicized language no less: "In contrast, the defintion of 'ultimate net loss' here is neither incorporated into, referenced, nor a part of the central insuring clause of the [] policy." (Slip op. at 14, original italics omitted). Accordingly, the court holds:

We conclude that costs and expenses associated with responding to administrative orders to clean up and abate soil or groundwater contamination outside the context of a government-initiated lawsuit seeking such remedial relief, and property buy-out settlements negotiated with third party claimants outside the context of a court suit, do not fall within the literal and unambiguous coverage terms of the [] policy's insuring agreement.

Slip op. at 16 (emphasis in original). Three of the six current California Supreme Court justices, however, indicated their disagreement with the merits of the holding of the opinion for the court.

The three dissenting justices no doubt are right (in my judgment) that it is, shall we say, quirky to have the case law end up where it is as of yesterday. In some ways, a more rational result would have been to deny coverage to Powerine, too, at least to accomplish some degree of aesthetic consistency (and lest there be any misunderstanding I think the original ruling by the court in the earlier case limiting coverage to amounts awarded in court, was plainly wrong). Now, at least in California, we need to scrutinize policies not just for the word "expenses" but also for its coordinates within the policy.

There is an important, broader implication of this duet of opinions: policyholders need to be vigilant in notifying umbrella carriers (and presumably the following-form tower) whenever some form of unconventional relief, i.e., other than pure compensatory damages, is sought against it, whether it be in a court proceeding or in an administrative proceeding. Accordingly, a claim for medical-monitoring, which some insurers have challenged as "non-damages", should be noticed to the umbrella carriers to guard against the risk that those amounts might be considered to be "expenses" rather than "damages" (no matter how unreasonable that result might be). Similarly, whenever a policyholder is interested in settling with a claimant prior to litigation, the policyholder should notify the umbrella carriers, for any such payment might (under current California authority) be found not to be covered "damages" either.

Of course, this all will create new burdens on umbrella carriers, who typically rely on the primary insurer for everyday claims handling. But according to the California Surpeme Court nowadays, we simply must assume the umbrella carrier had the contractual intent to cover claims settled before court proceedings start and forms of monetary relief other than traditional compensatory damages.

Posted by Marc Mayerson at 2:49 PM | Comments (0) | TrackBack
March 11, 2005
Silica Bodily Injury Claims: 'Polluting' the Injured ?

The California Court of Appeal recently held that bodily injury claims arising from workplace silica exposure were the result of pollution, the coverage for which was barred by an absolute pollution exclusion. Garamendi v. Golden Eagle Ins. Co. (March 9, 2005). Importantly, and a distinction that will be lost in the sands of time, the decision effectively employs an abuse-of-discretion standard to evaluate the decision of a claims determination of an insurer in liquidation.

In 2003, the California Supreme Court held that residential spraying of pesticide was not within the scope of the pollution exclusion, MacKinnon v. Truck Ins. Exchange, 31 Cal. 4th 635 (2003). The present case involved a defendant in two actions, filed in Mississippi, that alleged that the plaintiffs were exposed to silica through their employment, stemming from the sale of silica products, the use of defective respiratory equipment, and sandblasting. The nature of the claim against the insured sounded in product liability. The court did not hold that silica dust fell within the meaning of the specifically excluded “soot,” but instead found it to be within the more broadly descriptive “irritant or contaminant.” The court ex cathedra states that “the widespread dissemination of silica dust as an incidental by-product of industrial sandblasting operations most assuredly [?] is what is ‘commonly though of as pollution’ and ‘environmental pollution.’” (slip op. at 5, citing MacKinnon) (emphasis added).

Moreover, the court rejected the contention, often urged by policyholders, that applying the exclusion to this type of claim unreasonably and inappropriately cuts back coverage for the insured’s products liability, without the insured’s having been provided with fair notice of the need to buy back the exclusion when purchasing the policy. In other words, the policy as construed here negates the most substantial exposure to bodily injury claims that a maker of, e.g., sandblasting equipment might face. Compare West American Ins. Co. v. Tufco Flooring East, Inc., 409 S.E.2d 692, 699 (N.C. App. 1991) (“To allow West American to deny coverage for claims arising out of Tufco’s central business activity would render the policy virtually worthless to Tufco. If this Court accepted West American’s interpretation of the CGL policy, we would be allowing an insurance company to accept premiums for a commercial general liability policy and then to hide behind ambiguities in the policy and deny coverage for good faith claims that arise during the course of the insured’s normal business activity.”); American States Ins. v. Kiger, 662 N.E.2d 945 (Ind. 1996). Many courts – though assuredly not all – have reasoned that such an construction would need to be particularly plain and unmistakable before it can be enforced, given that it so goes against the reasonable expectations of a purchaser of product-liability coverage. Compare Haynes v. Farmers Insurance Exch., 32 Cal.4th 1198 (2004). The recent decision in Haynes is instructive in this regard inasmuch as the Court there held that even though policy language literally applied to limit coverage the limitation was not reasonably called to the insured’s attention due to its placement in the policy and other indications that coverage would be afforded.

The argument of policyholders regarding products and the pollution exclusion is not that there is a sub silentio limitation on the scope of the exclusion’s (overly) broad reach, but rather that a construction that would negate the core coverage for products liability must be one that is ineluctably compelled and particularly clear to a lay person, since it does such violence to the purpose of buying product-liability insurance. The new California appellate case grounds its reasoning in part on federal regulations that classify silica dust as a contaminant (slip op. at 5), yet it simultaneously concedes that in some circumstances silica dust should not be considered an irritant or contaminant. Given MacKinnon and Haynes, the court’s bottom-line no-coverage ruling (as distinct from its rationale) can best be harmonized by its employing abuse-of-discretion review (but even then the denial of coverage plausibly is beyond that even what that deferential review should uphold); at all events, this is the type of decision that would seem to be appropriate for the California practice of depublication, given that its most legitimate rationale does not have significance outside the insurer-liquidation context and that its loose language is irreconcilable with governing California Supreme Court precedent (MacKinnon and Haynes).

Posted by Marc Mayerson at 4:19 PM | Comments (0)
March 8, 2005
Food-Related Losses and Insurance

The courts continue to construe insurance coverage very broadly regarding food-related losses. See Mayerson, Insurance Recovery for Losses from Contaminated or Genetically Modified Foods, 39 Tort Trial & Ins. L. J. 837 (2004), available at http://www.spriggs.com/news/pdfs/ACF6453.pdf Insurance companies need to be mindful in handling claims that the courts for decades have approached these coverage disputes this way.

Two recent examples consistent with the existing case law: one involves what is covered damage to property and the other involves what is (not) excluded contamination.

In one case, a warehouse company inadvertently was not rotating stock as it should with the result that cans of juice were being held in inventory longer than intended. Once the mistake was realized, the juice was sold to retailers; the problem was that the “sell by” date was fast approaching (put differently, although the juice cans were being delivered such that they could be sold before the sell-by date, the retailer had a shorter time period than ordinarily was the case within which to sell the product). Consequently, retailers were unwilling to pay the regular cost of the product. The question presented was whether the reduction in price – caused by depression on the demand side rather than by tangible degradation – was tantamount to loss from injury to the property. The New Jersey appellate court said yes. http://lawlibrary.rutgers.edu/decisions/appellate/a1586-03.opn.html
As the court explained:

“Here, what occurred was that the Splash beverage changed. Granted, it was not a change in material composition but in how the product was perceived by Campbell’s customers as a result of an undue passage of time. The change stemmed from [the warehouser’s] alleged fault in handling the task of product rotation. In our view, such a change is the functional equivalent of damage of a material nature or an alteration in physical composition. By reason of this change, and of the ensuing new perception of the covered property and its nature, the product lost value as much from the outdating as if it had turned sour or gone bad in some more tangible or material way. It occurred essentially in the same manner and with virtually the same effect. We conclude that the policy is clear as a matter of law in this respect.” (p. 11)

This case is an example of how broadly courts construe what I have elsewhere termed “prong 1” property damage coverage, that is, physical damage claims. See generally S. Wallace Edwards v. Cincinnati Ins., 353 F.3d 367, 375 (4th Cir. 2003) (exposure of hams to ammonia gas caused physical damage even if ammonia levels were not harmful). Had the court not found prong 1 coverage, coverage would have been triggered by prong 2 of the typical property damage definition, viz. loss of use of tangible property that is not physically injured. See Lucker Mfg. v. Home, 23 F.3d 808, 815 (3d Cir. 1994) (non-food context but key discussion on how a impact on demand for a product constitutes covered loss of use). The insured may have shied away from making the prong 2 arguments (which turned out not to be necessary), because there was a loss-of-use exclusion (though the context is such that it may not have applied even if the reduced price were considered as loss-of-use property damage).

In another case, a soft-drink manufacturer’s product had been contaminated with a substance that made it displeasing but not toxic. The manufacturer destroyed the affected bottles, and the court found there was damage to covered property and that a contamination exclusion in the policy did not apply. http://www.courts.state.ny.us/reporter/3dseries/2004/2004_09611.htm This is consistent with earlier case law. E.g., Allianz v. RJR Nabisco, 96 F. Supp. 2d 253 (S.D. N.Y. 2000).

Posted by Marc Mayerson at 10:00 AM | Comments (3)