Archive for the ‘Insurance Practices’ Category

Eleventh Circuit Recognizes Important Exception to the Eight Corners Rule

Tuesday, April 15th, 2014

By Eryk Gettell, Sedgwick San Francisco

Florida courts generally adhere to the Eight Corners Rule when determining whether an insurer has a duty to defend its insured.  Under this rule, the duty to defend determination is made by looking only at the terms within the four corners the insurance policy and the allegations within the four corners of the complaint.  Extrinsic evidence may not be considered.  Recently, however, in Composite Structures, Inc. v. Continental Insurance Co., 2014 WL 1069253 (11th Cir. March 20, 2014) (unpublished), the United States Court of Appeals for the Eleventh Circuit (applying Florida state law) recognized an important exception to the Eight Corners Rule – when an insurer’s coverage denial is based on factual issues that ordinarily would not be alleged in the complaint, the insurer may consider extrinsic evidence outside of the complaint.

The underlying lawsuit was brought by two seamen who sustained carbon monoxide poisoning while aboard a boat.  The seamen sued the insured boat manufacturer for negligence and strict liability, and the insured tendered its defense to Continental Insurance Co.  Continental disclaimed coverage for the underlying suit because the insured first discovered the occurrence more than 72 hours after its commencement.  As a result, the insured had not satisfied the conditions of the pollution buyback endorsement that created exceptions to the pollution exclusion in the two general liability policies at issue. 

In the declaratory judgment action brought by the insured, Continental successfully argued in the district court that the conditions in the pollution buyback endorsement were not satisfied because the insured did not first discover the occurrence within 72 hours after its commencement, and because the occurrence was not timely reported to Continental.  On appeal from the district court’s summary judgment ruling, the insured argued that the district court erred in considering evidence outside of the underlying complaint in determining Continental’s coverage obligations.

The Eleventh Circuit affirmed the district court’s decision.  The appellate court recognized that Florida courts generally follow the Eight Corners Rule.  However, the court also noted that the Florida Supreme Court has recognized certain exceptions to this rule, including that insurers may look to facts outside of the underlying complaint when the basis for the insurer’s declination involves facts that normally would not be alleged in the complaint.  Here, the court observed that the underlying complaint involved negligence and strict liability claims, neither of which required the plaintiffs to allege the date of when the insured notified its insurer of the occurrence.  Thus, the Eleventh Circuit held that, “[u]nder Florida law, Continental was permitted to consider the uncontroverted date of written notice when determining its duty to defend because the date of written notice to the insurance company is not a fact that would normally be alleged in the complaint.” 

On April 7, 2014, Continental filed a motion for publication with the Eleventh Circuit and urged the court to publish its decision.  The insured has not opposed Continental’s motion at this time.  Interested readers should stand by, as a published opinion would have a significant impact on lower courts in the Eleventh Circuit.

In January 2014, we looked at the Eight Corners Rule as it applies in Texas.  Click here to read more.

New Jersey Legislature Passes Superstorm Sandy Bill of Rights

Monday, March 31st, 2014

By Ryan Chapoteau, Sedgwick New York

We previously reported on the New Jersey legislature’s attempt to pass reform bills as a response to Superstorm Sandy.  Although New Jersey Assembly Bill A3710 died when referred to the Financial Institutions and Insurance Committee, the legislature recently passed Senate Bill S1804 (combined with S1306), which details how the state can distribute Superstorm Sandy federal aid relief, and established a Bill of Rights for Superstorm Sandy victims.

In relevant part, the Bill of Rights helps to ensure that victims of Superstorm Sandy can seek compensation from multiple recovery programs as well as through any applicable insurance.  If a victim is not wholly compensated through their insurance carrier, the Bill of Rights can apply to a governmental recovery program to aid in the victim’s effort to be made whole for any losses resulting from the storm.  According to this law, the State cannot deny applicants seeking aid merely because they have other applications pending for financial relief.  Now, victims have multiple avenues to be compensated for the damage occurred by Superstorm Sandy.

In June 2013, we reported on the 12 new insurance reform bills bassed by the New York State Assembly in response to Superstorm Sandy. 

Interrupted by Sandy

Friday, March 28th, 2014

By Benjamin E. Shiftan, Sedgwick San Francisco

In Johnson Gallagher Magliery, LLC v. The Charter Oak Fire Insurance Company, 2014 WL 1041831 (S.D.N.Y. Mar. 18, 2014), the United States District Court for the Southern District of New York, granting a motion for partial summary judgment, held that a law firm was not entitled to certain lost business income caused by Superstorm Sandy.

The law firm leased office space at 99 Wall Street in New York City.  The building was supplied electricity from the Consolidated Edison of New York Bowling Green Network.  On the evening of October 28, 2012, due to the looming storm, the office space at 99 Wall Street was evacuated.  The next night, on October 29, 2012, ConEd preemptively shut down the Bowling Green Network to prevent major customer and network damage.  When Superstorm Sandy hit, flooding damaged the Bowling Green Network equipment.  The Bowling Green Network was re-energized on November 3, 2012, but 99 Wall Street did not actually receive electricity until November 11, 2012.

The law firm filed a claim with its business casualty insurer, The Charter Oak Fire Insurance Company, for, amongst other things, lost business income.  Charter Oak denied the claim, citing the water exclusion in its policy.  In the ensuing insurance coverage litigation, Charter Oak filed a motion for partial summary judgment which asserted that the policy’s water exclusion barred coverage for the law firm’s lost business income when that loss was due to the interruption of electrical service by way of the Bowling Green Network, which had suffered water damage.

The Southern District of New York ruled that Charter Oak was not obligated to pay for business losses that the law firm sustained during the time period when the Bowling Green Network was shut down, from October 29, 2012 through November 3, 2012.  The court held, in part, that the water exclusion applied to business losses stemming from the shutdown of the Bowling Green Network, which suffered water damage that prevented the re-energizing of the network until November 3, 2012.  In so ruling, the court relied on deposition testimony from a ConEd senior engineer who confirmed that there was extensive water damage to the Bowling Green Network.

Homeowners Beware: Fraud in Claims Process Can Lead to Judicial Sanctions in Bad Faith Action

Thursday, March 13th, 2014

By Beth E. Yoffie, Sedgwick Los Angeles

A federal court for the Southern District of Texas has sanctioned a pro se litigant for making fraudulent misrepresentations to his homeowner’s insurer following a fire, and for bringing a bad faith action against the insurer.

In Alexander v. State Farm Lloyds, 4: 12-CV-490, 2014 WL 549389 (S.D. Tex. Feb. 11, 2014), Tony Alexander sued State Farm Lloyds (“State Farm”) for breach of contract, violations of the Texas Insurance Code, violations of the Texas Deceptive Trade Practices Act, and bad faith.  He sought more than $1 million under the policy’s Dwelling Coverage as well as $77,000 for the cost of additional living expenses, personal property damage, and securing of the residence.  He did so despite concealing material facts and making misrepresentations to State Farm during the claims process.

Mr. Alexander abandoned the case three days into the jury trial after his fraudulent conduct had become apparent.  Following that, State Farm moved for sanctions to be levied against him.  Mr. Alexander retained counsel, who argued that he could not be sanctioned because his “foolishness” had taken place before he had filed the lawsuit.  Counsel asserted that Mr. Alexander had not lied during the trial, and so had not displayed contempt for the judicial process.  The court disagreed.

Mr. Alexander’s decision to file suit was itself contemptuous.  The court found that he was a sophisticated individual, given he had worked in the finance industry, possessed an advanced degree, and previously operated multiple businesses; and, that he had connived to use the judicial system as a continuation of his lawless efforts to exploit the July 24, 2005 fire to squeeze additional money from State Farm.

The court concluded that, although Rule 11 did not permit sanctions on the facts before it, attorney’s fees could be awarded to State Farm under Texas Rule 13 and Chapter 10 of the Civil Remedies and Practices Code.  Accordingly, it awarded attorney’s fees to State Farm.

Fourth Circuit Holds that Contingent Business Interruption Endorsement Does Not Extend to Indirect Suppliers

Monday, March 10th, 2014

By Mari C. Spears, Sedgwick Washington, D.C.

On February 20, 2014, the United States Court of Appeals for the Fourth Circuit held that a contingent business interruption endorsement did not extend coverage to claims arising out of a business interruption caused by an indirect supplier.  Millennium Inorganic Chemicals Ltd. v. National Union Fire Insurance Co. of Pittsburgh, PA, 13-1194, 2014 WL 642993 (4th Cir. Feb. 20, 2014).

Millennium Inorganic Chemicals Ltd. and Cristal Inorganic Chemicals Ltd. (collectively, “Millennium”) was in the business of processing titanium dioxide, a compound often used for its white pigmentation, at its processing facility in Western Australia.  Millennium’s titanium dioxide processing operation was fueled by natural gas through the Dampier-to-Bunbury Natural Gas Pipeline (the “DB Pipeline”), Western Australia’s principal gas transmission pipeline.  Millennium purchased the gas under a contract with Alinta Sales Pty Ltd (“Alinta”), a retail gas supplier, which had purchased the gas from a number of natural gas producers, including Apache Corporation (“Apache”).  Millennium’s contract for the purchase of natural gas was solely with Alinta.

On June 3, 2008, an explosion occurred at Apache’s Varanus Island facility, causing its natural gas production to cease.  As a result of the explosion, Millennium’s gas supply was disrupted, and it was forced to shut down its titanium dioxide manufacturing operations for a number of months.

On June 5, 2008, Millennium tendered its claim to National Union Fire Insurance Company of Pittsburgh, PA and ACE American Insurance Co. (the “Insurers”), seeking contingent business interruption (“CBI”) coverage for losses incurred when the titanium dioxide manufacturing operation was shut down.  The policies included a CBI Endorsement that insured Millennium against certain losses resulting from the disruption of the supply of materials to Millennium caused by damage to certain “contributing properties.”  The term “contributing properties” was defined as “the insured’s prime suppliers of materials, parts and services.  If the insured depends upon one or, at most, a few manufacturers or suppliers for the bulk of materials and supplies necessary to conduct its business operations, then these suppliers are said to be “contributing properties.”  The Endorsement further defined “contributing property” by reference to the policy schedules, which indicated that covered locations “must be direct suppliers of materials to [Millennium’s] locations.”

The Insurers denied Millennium’s claim on the ground that Apache was not a direct supplier to Millennium as required under the policies.  Millennium subsequently sued the Insurers in the U.S. District Court for the District of Maryland, contending that the Insurers wrongfully denied Millennium’s claim for coverage under the CBI Endorsement.

The district court concluded that coverage under the policies extended only to “direct contributing properties”; however, the district court also held that none of the evidence “speaks to the specific meaning the parties intended by the use of the word ‘direct.’”  The district court ruled that the term “direct” was ambiguous in the context of an entity that provides a direct physical supply of material to the insured, but has no direct contractual relationship with the insured.  Accordingly, the district court, construing the term in favor of the insured, held that Apache qualified as a “direct” supplier to Millennium, and Apache’s natural gas production facility was a “direct contributing property” within the meaning of the policies “because Apache’s facility physically provided a direct supply of natural gas to Millennium’s premises, despite the fact that Apache and Millennium had no direct contractual relationship.”

On appeal, the Fourth Circuit reversed the judgment of the district court and remanded the case for entry of summary judgment in favor of the Insurers on the ground that neither Apache nor Apache’s facilities on Varanus Island could be considered a “direct contributing property” of Millennium.  The Fourth Circuit held that the term “direct” meant “proceeding from one point to another in time or space without deviation or interruption,” “transmitted back and forth without an intermediary,” or “operating or guided without digression or obstruction.”  It was undisputed that Millennium received its gas from Alinta, and Alinta, not Apache, had the sole ability to control the amount of gas directed to Millennium.  It also was undisputed that Millennium received its gas by way of the DB Pipeline, and that the DB Pipeline was neither owned nor operated by Apache and Apache relinquished both legal title and physical control over the gas when it entered the DB Pipeline.  Therefore, the court concluded that the relationship between Apache and Millennium, if any, was clearly interrupted by “an intermediary,” Alinta, who took full physical control of Apache’s gas before delivering indistinguishable commingled gas to Millennium.

“FAIR” is Fair: California Policyholders Not Entitled to Recovery Beyond Specified Policy Limits for Fire Losses

Friday, March 7th, 2014

By Michael A. Topp, Sedgwick San Francisco

Recently, the California Court of Appeal held that recovery under a standard California fire policy is limited to the specified policy limits, even if the actual cash value of the loss exceeds those limits.

The California FAIR Plan Association (the “FAIR Plan”) was established by the California legislature in 1968 to make available “basic property insurance” to property owners who are unable to procure such insurance through normal channels from an admitted insurer.  The FAIR Plan is an involuntary joint reinsurance association of all insurers authorized to write property insurance in California.  The governing statutes require the FAIR Plan to provide insurance for the peril of fire which is equivalent to, or more favorable than what is contained in, the standard form fire insurance policy set forth in Insurance Code § 2071.

In St. Cyr v. California FAIR Plan Assn., ___ Cal.App.4th ___, 2014 WL 346074 (2d Dist. Jan. 31, 2014), the plaintiffs were policyholders who lived in high fire risk areas and whose homes were destroyed in a wildfire.  Despite having been paid the full amount of their policy limits for destruction of their properties, the policyholders sued the FAIR Plan for breach of contract, bad faith, and unfair business practices.  Specifically, the policyholders argued that, although standard fire policies require payment for actual cash value of dwelling loss and the actual cash value of their homes exceeded their policy limits, the FAIR Plan limited payment to the policy limits.

The court rejected the policyholders’ argument based on the express language of Section 2071, and sustained the trial court’s dismissal of the action.  The court noted that the statutorily-required policy language provides that fire coverage is afforded “to the extent of the actual cash value of the loss,” but also that coverage is provided “to an amount not exceeding _____ dollars.”  Thus, the stated limit of insurance “fixes the maximum amount due under the policy.”  The court also noted that, under Insurance Code § 2051, which specifies the “measure of indemnity” under an “open” policy, loss payment is determined based on the lesser of the policy limit or the cost to repair and/or replace the damaged property.  Therefore, “[a]s appellants were paid the full amount of their policy limits, they were paid the amount due.”

It should be noted that, under California Insurance Code § 10102(e) and (f), a policy issued as “guaranteed replacement cost coverage” may not limit coverage to a specified amount.  The policy at issue in the St. Cyr case was described by the court as “bare bones” coverage, and did not implicate Section 10102.

 

5th Circuit Says the Issue is Liability, Not Damages

Tuesday, March 4th, 2014

By Daniel Pickett, Sedgwick New York

In Carl E. Woodward, L.L.C. v. Acceptance Indem. Ins. Co.,  2014 WL 535726, No. 12–60561 (5th Cir. Feb. 11, 2014)  the 5th Circuit Court of Appeals held that, when analyzing coverage under an additional insured endorsement that excludes completed operations, the focus of the inquiry is when the additional insured’s liability arose, not when the damage occurred.

In Woodward, Pass Marianne contracted with a general contractor, Woodward, for the construction of condominiums on the Mississippi Gulf Coast.  Woodward subcontracted with DCM for the concrete work.  Pass Marianne sold the condominiums to Lemon Drop Properties and, a year after purchasing the condominiums, Lemon Drop brought suit against Pass Marianne and Woodward asserting claims for rescission, breach of contract and gross negligence. Pass Marianne filed a cross-claim against Woodward alleging faulty construction of the condominiums.

The claims were eventually arbitrated and one of the significant issues in the arbitration was the fault of DCM.  After Pass Marianne asserted its cross-claims, Woodward demanded that DCM’s commercial general liability carrier, Acceptance Indemnity Corporation, provide a defense and indemnity.  Acceptance denied the tender.  As a result, Woodward and its insurer filed suit against Acceptance.  The Acceptance policy provided that Woodward was an additional insured, but only with respect to liability arising out of DCM’s ongoing operations performed for Woodward. Additionally, the additional insured endorsement excluded coverage for property damage occurring after all work to be performed by or on behalf of Woodward at the site had been completed.

Woodward and its insurer moved for summary judgment. The district court held that Acceptance had a duty to defend and Acceptance appealed.  On appeal, the 5th Circuit focused on the portion of the additional insured endorsement that excluded coverage for property damage occurring after all work had been completed.  While noting that Mississippi’s highest court had not addressed the issue, the 5th Circuit concluded that, under the terms of the endorsement, claims for liability can be brought after ongoing operations are complete, but the underlying liability cannot be due to the completed operations. The court explained “that liability for construction defects, while created during ongoing operations, legally arises from completed operations.”  Accordingly, the court reasoned that the issue was not whether DCM failed to comply with plans and specifications during ongoing operations, but whether Woodward’s liability arose out of those ongoing operations. “It did not. Woodward’s liability for breach of contract, if any, flows from defects in the completed construction project.”

Accordingly, the court held that, even if it accepted the district court’s factual finding that damage had occurred during ongoing operations, the liability for such damages arose out of completed operations for which Woodward was not an additional insured under the policy.  As a result, Acceptance had no duty to defend Woodward.

 

Could an Insurer’s Declaratory Judgment Action Waive the Right to Participate in Settlement in Illinois?

Friday, February 21st, 2014

By Kirk C. Jenkins, Sedgwick Chicago

An insurer offers its insured a defense under a reservation of rights and files a complaint seeking a declaratory judgment determining coverage.  This is not an uncommon sequence of events, either in Illinois or anywhere else.  But does the insured then have the right to settle the case on its own, without the insurer’s consent?

Until recently, the answer under Illinois law has been clear: No.  But in a decision published in the last days of January, the Appellate Court for the Fourth District cast doubt on that conclusion.

Standard Mutual Insurance Company v. Lay was one of the Illinois Supreme Court’s major decisions of last year.  Our coverage of the decision is here.  Our report on the oral argument before the Supreme Court is here.

The defendant was a small real estate agency in Girard, Illinois.  The defendant hired a fax broadcaster to send a “blast fax” advertising a particular listing to thousands of fax machines.  The broadcaster claimed that each potential recipient had consented to receiving the faxes, and the defendant trusted the broadcaster’s word.  The problem was apparently it wasn’t true.

Enter the Telephone Consumer Protection Act of 1991, 47 U.S.C. § 227.  The statute imposes a penalty of $500 for each unsolicited fax sent, which is trebled for willful violations.  So the defendant was hit with a putative class action complaint, alleging willful violations of the TCPA, conversion and violations of the Illinois Consumer Fraud and Deceptive Business Practices Act, 815 ILCS 505/2.

The defendant tendered to its insurer, which accepted under a reservation of rights.  The insurer offered the defendant a defense (while noting its potential coverage defenses and the arguable conflict of interest).  The defendant signed the waiver of the conflict proferred by the insurer and accepted the attorney.

In mid-July 2009, the putative class action was removed to Federal court.  Not long after, the owner of the defendant real estate agency died, and his widow received letters of office.  In late October, at the widow’s behest, a new lawyer wrote to the lawyer hired by the insurer, explaining in great detail the conflict between the insurer and the insured (which the insured had waived) and asking the lawyer to withdraw.  The lawyer hired by the insurer never withdrew, but a few weeks later, the new attorney and the insured signed a settlement agreement.

In 2010, the settlement agreement was filed and ultimately approved.  It provided for a payment of $1,739,000: $500 per fax for each and every one of alleged 3,478 recipients.  Given that a finding of willful conduct – the necessary prerequisite to trebling – would have vitiated insurance coverage, this “settlement” amounted to the insured voluntarily paying 100 cents on the dollar on the case.  In return, the class representative agreed not to execute on any of the defendant’s assets, and seek to recover solely from the insurer (the covenant not to execute remained valid whether or not the insurer’s policy was adjudicated to cover the policy).

In mid-2011, the trial court granted the insurer summary judgment in the declaratory judgment action, finding that TCPA damages were in the nature of punitive damages and thus uninsurable.  The Supreme Court allowed a petition for leave to appeal and reversed on that point.  The Court remanded back to the Fourth District for consideration of the remaining issues – including whether the insured had breached the policy by settling without the insurer’s consent.

The Fourth District originally issued its opinion reversing the Circuit Court in late November 2013, but later granted a motion for publication.  The published opinion appeared January 25, 2013.

The court found that all three policies at issue covered the defendant’s “settlement.”  One expressly related to the real estate business.  The two remaining policies related to rental premises or vacant lots owned by the insured, but neither included “designated premises” limitations.

The insurer argued that the settlement was excluded from coverage by the professional services exclusion, but the Appellate Court disagreed.  The real estate agency was not a professional advertiser, the court pointed out.  The court specifically held that the TCPA damages were covered by both the property damage coverage and the advertising injury coverage.

But the most important part of the ruling came in two paragraphs on the final page of the opinion.  The court noted that where an insurer had provided an attorney pursuant to a reservation of rights, noting the potential conflict of interest, “the insured is entitled to assume control of the defense.”  At that point, the court held, the insurer lost the right to prevent the insured from unilaterally settling: “When an insurer surrenders control of the defense, it also surrenders its right to control the settlement of the action and to rely on a policy provision requiring consent to settle.”  The court cited Myoda Computer Center v. American Family Mutual Insurance Co. in support of its holding.  The insured’s liability was “clear,” the court commented, the settlement amount “was supported by simple math,” and “[a]bsent the settlement, the result would have been the same.”  Therefore, the court held, the insurer was liable for the full amount.

The insurer has petitioned the Supreme Court for leave to appeal the case once again.  A copy of the insurer’s petition is here.  There, the insurer pointed out the grave implications of the Appellate Court’s holding approving of the insured’s behavior: “The Appellate Court’s decision sanctions an insured rolling over on its insurer anytime a defending insurer reserves its rights and files a declaratory judgment action.”  The Appellate Court had simply gotten the law wrong, the insurer argues.  Myoda involved an entirely different situation, where the insurer had allowed the insured to choose its own counsel from the outset, merely reimbursing costs.  The insurer had been told of a prospective settlement and flatly refused to participate – something which never happened in Standard Mutual.  The insurer argued that pursuant to long-settled Illinois law, absent a breach of the duty to defend, an insurer has every right to insist on the right to approve of and participate in settlement.

The insurer offers this powerful argument for the potential for abuse of TCPA litigation inherent in the Fourth District’s decision:

[T]arget a defendant, ensure that it carries insurance coverage, offer the defendant a deal where it can walk away unscathed and in the process obviate the need for any proof that offending faxes were ever received, and cash in on the defendant’s insurance policies.  This game of ‘gotcha’ prejudices insurers which seek to honor their obligations while at the same time exercising their right to walk into court and seek a judicial declaration of their coverage.

The Fourth District’s holding on remand in Standard Mutual is a significant potential threat to insurers operating in Illinois.  The insurer in Standard Mutual appears to have done everything right pursuant to a policy which expressly barred settlement without its consent: it provided (and paid for) counsel, carefully noted and reserved its coverage defenses and explained the potential conflict of interest, and offered the insured the opportunity to waive the conflict – which it did.  The insurer then exercised its clear right to seek a judicial determination of coverage.  As a result, the insurer was held liable for a 100-cents-on-the-dollar “settlement” entered into unilaterally by the insured.

The Supreme Court should allow this new petition for leave to appeal in Standard Mutual Insurance Co. v. Lay and hold that insurers do not authorize collusive settlements by their insured simply by virtue of proceeding pursuant to their rights under the policy.

 

New York’s Highest Court Rappels Down From Possible Major Shift in Insurance Law in K2 Decision

Tuesday, February 18th, 2014

By Katelin O’Rourke Gorman and Greg Lahr, Sedgwick New York

Today, the New York Court of Appeals elected to adhere to precedent in holding that an insurer is indeed allowed to rely on its policy exclusions when faced with a request for indemnity, even if the insurer was not correct in deciding that it did not have a duty to defend. K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co., — N.Y.3d –, 2014 WL 590662 (N.Y. Feb. 18, 2014) (“K2-II”). The K2-II decision follows reargument of an earlier decision by the Court of Appeals issued on June 13, 2013. 21 N.Y.3d 384, 971 N.Y.S.2d 229 (N.Y. June 11, 2013) (“K2-I”).

As background, legal malpractice claims had been brought against American Guarantee & Liability Insurance Company’s insured, Jeffrey Daniels. American Guarantee determined that its legal malpractice policy did not cover the claim and, therefore, it did not owe a defense to Daniels, although the court decided otherwise. K2-II at 2. In the underlying malpractice action, the court entered a default judgment against Daniels. Daniels then assigned his rights under the American Guarantee policy to plaintiffs. Plaintiffs, in turn, brought suit against American Guarantee seeking coverage for the judgment entered against Daniels. American Guarantee maintained it had no obligation to provide indemnification for the judgment because “the loss sought was not covered[.]” K2-II at 2. The trial court disagreed with American Guarantee’s position, and granted plaintiffs’ motion for summary judgment. This determination was affirmed on two appeals, the latest under K2-I, on the basis that “American Guarantee’s breach of its duty to defend barred it from relying on policy exclusions.” K2-II at 2.

American Guarantee requested a re-hearing of the K2-I decision, which the Court of Appeals granted on September 3, 2013. Upon rehearing, the court agreed with American Guarantee, noting that the court had failed to “take account of a controlling precedent, Servidone Const. Corp. v. Security Ins. Co. of Hartford (64 NY2d 419 [1985]).” K2-II at 1-2. As a result, the Court of Appeals vacated its decision in K2-I, and reversed the Appellate Division’s order.

The Court of Appeals’ decision in K2-II is largely tied to Servidone. At issue in Servidone was whether an insurer that had breached its duty to defend would be barred from raising coverage defenses to a request for indemnification of a subsequent, reasonable settlement. There, the answer was no; the insurer would not be barred from raising potentially applicable coverage defenses. See K2-II at 2-3. In K2-I, the Court of Appeals had held that, “when a liability insurer has breached its duty to defend its insured, the insurer may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him.” K2-II at 3 (citations omitted). In reaching today’s decision, the Court of Appeals stated that, “[t]he Servidone and K2-I holdings cannot be reconciled.” K2-II at 3. The Court of Appeals also: (1) rejected plaintiffs’ attempt to distinguish Servidone because it involved a settlement, rather than a judgment as was the case in K2; (2) stated that Lang v. Hanover Ins. Co., in which the Court of Appeals held that, “when an insurer has refused to defend its insured, it may litigate only the validity of the disclaimer,” did not apply because “the issue we now face was not presented in Lang,” i.e., “we did not consider any defense based on policy exclusions;” (3) pointed to various other jurisdictions that follow the Servidone approach; and (4) invoked the rule of stare decisis, stating that it is “strong enough” to govern this case. K2-II at 3-6 (citations omitted).

The K2-II decision will come as a relief to insurers, as the Court of Appeals potentially was going to blaze a new path for New York insurance law and significantly restrict an insurer’s ability to deny coverage under an applicable policy exclusion. The court aptly noted: “When our Court decides a question of insurance law, insurers and insureds alike should ordinarily be entitled to assume that the decision will remain unchanged unless or until the Legislature decides otherwise.” K2-II, at 6. However, insurers should be mindful that the rule still exists in New York that, if it does not provide a defense to its insured, it may not relitigate the issues in the underlying action.

With Tax Season Looming, Appellate Division Refuses to Find Duty to Defend Against IRS Action

Wednesday, February 5th, 2014

By Daniel E. Bryer, Sedgwick New York

In William B. Kessler Memorial Hosp., Inc. v. North River Ins. Co., 2013 WL 6036678 (N.J. Super. Nov. 15, 2013), the Superior Court of New Jersey, Appellate Division, rejected the notion that an insurer’s promise to “defend any Claim” included a duty to defend against an Internal Revenue Service (“IRS”) action seeking taxes and penalties where taxes and penalties were excluded by the policy.

Defendant North River Insurance Company (“North River”) issued a one-year claims-made “Platinum Management Protection” liability insurance policy to plaintiffs William B. Kessler Memorial Hospital, Inc. and Foundation of William B. Kessler Memorial Hospital.  Nine trustees of the Kessler entities were “Insured Persons” under the policy, and plaintiffs in the action against North River.

Beginning in 2009, the IRS sought to collect unpaid section 941 employment taxes from plaintiffs.  Plaintiffs requested that North River defend and indemnify them pursuant to the policy.  North River denied coverage because the IRS action sought taxes and penalties, which were excluded under the policy.  Plaintiffs initiated a declaratory judgment action, claiming North River owed a defense even if taxes and penalties were excluded under the policy because the IRS action fell within the definition of “Insured Person Claim” and North River agreed to “defend any Claim.”

The Court ruled that plaintiffs’ potential exposure to the IRS’s “effort to impose responsibility for section 941 liabilities is undoubtedly either a tax or a penalty” and, therefore, excluded under the policy.  Id. at *3.  The Court rejected plaintiffs’ argument that the “General Conditions” section of the policy created an independent duty to defend against an “Insured Person Claim” regardless of whether the loss was contemplated by the policy.  The Court ruled that plaintiffs’ “universal-right-to-a-defense contention” failed because it “fundamentally change[d] the nature of the policy that was purchased” by transforming the policy “into a contract for unlimited legal services.”  Accordingly, the Court maintained that, “[w]hen a claim is one that ‘even if successful, would not be within the policy coverage,’ there is no duty to defend.”  Id. at *4 citing Danek v. Hommer, 28 N.J. Super. 68, 77 (App. Div. 1953), aff’d, o.b., 15 N.J. 573 (1954).

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