Corporate Policyholder Magazine | January 2019

POLICYHOLDER

Volume 2

CORPORATE Risk. Recover. Repeat.

IN THIS ISSUE: RECOVERING CONSEQUENTIAL DAMAGES UNDER GENERAL LIABILITY POLICIES

22

DO YOU KNOW WHAT YOUR DEDUCTIBLE WILL BE WHEN THE NEXT BIG STORM HITS?

26

IS EMPLOYED LAWYERS INSURANCE WORTH THE PAPER IT’S PRINTED ON?

34

LETTER FROM THE PUBLISHER

TABLE OF CONTENTS

Dear Readers, We are pleased to bring you another issue of Corporate Policyholder magazine, a publication of the Barnes & Thornburg Insurance Recovery and Counseling Practice Group. In the following pages, we explore for the second year the challenges facing businesses, public entities and nonprofits in mitigating and transferring risk, principally through insurance.

Our articles delve into the issues that transcend the rising economic tide to look at some risks that smart companies are preparing for, as well as a glimpse into an insurance claim department to get a view of the nuts and bolts that build the insurance process we experience.

The surprise of Hurricane Harvey is almost impossible to overstate. Even the best prepared found themselves dealing with a magnitude and duration of disruption that left a giant, populous and economically vital Texas gulf coast region reeling. As a result, and with the recent passage of Hurricanes Florence and Michael, we explore a lesson for future storms: evaluating your deductible for when natural disasters inevitably hit.

Another storm, quietly gathering for years, has now broken across U.S. business: the opioid crisis. The misuse of prescription pain relievers, heroin and

synthetic opioids costs the country almost $80 billion per year in healthcare expenses, addiction treatment, criminal justice involvement and lost productivity, according to Centers for Disease Control and Prevention estimates. Insurers play a critical role in building and adapting the incentives around prescribing and treating addiction for these drugs, and understanding this perspective is equally critical to understanding how to manage your company’s risk.

This magazine is the journal of our practice, written for insurance professionals responsible for the all-important insurance recovery function inside and outside U.S. companies. We aim to speak as clearly to the risk managers who forecast risk and plan how to protect their companies as we do to the legal departments who must keep insurers accountable to the obligations of the companies’ policies.

It’s not as easy to discuss the dangers facing our industry in 2018 as it was in past years when the economy wasn’t growing strongly, adding jobs and lifting business optimism. But that doesn’t mean the coast is clear. Prosperity alone is a terrible excuse to feel immune from threats or become complacent.

Insurance Recovery and Counseling Practice Group Barnes & Thornburg LLP

Our articles delve into the issues that transcend the rising economic tide to look at some risks that smart companies are preparing for...

Page 4 Page 8 Page 12 Page 15 Page 20

2 | btlaw.com

Inside an Insurance Company How They Work and What Drives Them

Compassion Sometimes Backfires

Automatic Termination of Commercial Crime Coverage Upon Discovery of an Employee’s Prior Dishonesty

Past Tense

How Insurance Companies Try to Use Past Events to Defeat Coverage of New Claims

Case Summaries

Staying up to date on insurance policy law is critical. Here are a few significant insurance cases decided recently.

Page 22

Recovering Consequential Damages Under General Liability Policies

Page 26

Do You Know What Your Deductible Will Be When the Next Big Storm Hits?

Page 30

Allocation of Long-Tail Claims Among Multiple Policy Periods

Page 34

Is Employed Lawyers Insurance Worth the Paper It’s Printed On?

Page 37 For more insights, read the Policyholder Protection blog at www.btlaw.com/insights/blog.

Insurance Coverage for Defendants Named in Nationwide Opioid Litigation

Interview With Brooke Tassoni

Senior Lawyer, Litigation Practice Team Lead, Cargill Inc.

The articles in this publication should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer on any specific legal questions you might have concerning your situation.

2019 Corporate Policyholder | 3

INSURANCE COVERAGE FOR DEFENDANTS NAMED IN NATIONWIDE OPIOID LITIGATION

By Andrea Warren and Christian Jones

In a barrage of nationwide litigation, hundreds of lawsuits have been filed by states, counties and cities against pharmaceutical manufacturers and wholesale distributors seeking to recover costs allegedly incurred in responding to the opioid epidemic, estimated to impose $55 billion in health and related societal costs and $20 billion in emergency and inpatient costs in the United States each year. If history is any guide, as the number of lawsuits continues to grow, the field of actual and potential defendants likely will grow as well. As defendants mount a vigorous defense to these lawsuits, they must be conscious of how expensive a defense can be, regardless of whether the claims have merit.

These lawsuits target the perceived deep pockets, such as the pharmaceutical manufacturers and wholesale distributors, for allegedly causing opioid abuse by supplying opioids to the affected areas. The plaintiffs typically seek recovery of a variety of costs expended in connection with opioid abuse, including costs associated with treatment of opioid addiction and overdose, increased law enforcement and medical personnel and higher demands on hospitals and jails.

Going forward, manufacturers, distributors and other potential defendants must consider whether and how their liability insurance will respond to this rapidly growing litigation risk. Looking back, they must examine their historical insurance policies to find coverage. Thus far, they have primarily looked to their commercial general liability (CGL) policies, but other policies may be triggered as well, including directors’ and officers’ liability policies and professional errors and omissions policies.

Triggering CGL Policies There already has been fairly significant coverage litigation arising from the opioid lawsuits, and insurers

4 | btlaw.com

have quickly mounted standard lines of attack seeking to avoid coverage. For example, insurers have argued that these lawsuits are not covered by the CGL’s insuring agreement promising to cover “all sums that the insured becomes legally obligated to pay as damages because of bodily injury or property damage” caused by an “occurrence.” As discussed below, insurers have argued that certain claims alleged in the underlying opioid lawsuits do not arise from bodily injury, and also that they do not involve an “occurrence.”

CGL policies require insurers to defend their insureds for the entire lawsuit if any of the underlying allegations or claims against the insured are even potentially within the scope of coverage.

Thus, if an opioid lawsuit includes any allegation that even potentially falls within the scope of coverage, the insurer has a duty to defend the entire lawsuit.

intended to sell the pharmaceuticals at issue. Insurers also have made this intentional acts argument when invoking the exclusion typically found in CGL policies for “expected and intended” conduct.

dispensed the prescription drugs to people who presented seemingly valid prescriptions. There is no allegation that Richie ‘controlled’ the pharmacies – let alone to whom the pharmacists dispensed the drugs....” Id.

Courts have largely rejected the insurers’ “occurrence” argument, recognizing that these lawsuits allege or potentially involve negligent conduct, such as claims that a manufacturer or distributor negligently failed to monitor the volume of pharmaceuticals being shipped to a particular area. See, e.g., Cincinnati Ins. Co. v. Richie Enters.

LLC, 2014 WL 838768 (W.D. Ky. Mar. 4, 2014); Liberty Mut. Fire Ins. Co. v. JM Smith Corp., 2013 WL 5372768 (D.S.C. Sept. 24, 2013), aff’d 602 Fed. Appx. 115 (4th Cir. 2015); Cincinnati Ins. Co. v. H. D. Smith Wholesale Drug Co. 2015 WL 4624734 (C.D. Ill. Aug. 3, 2015), rev’d on other grounds, 829 F.3d 771 (7th Cir. 2016).

Similarly, in JM Smith, the court rejected the insurer’s “occurrence” argument by distinguishing between “intentional acts” of selling or distributing products and intending to cause injury due to later abuse of that product. 2013 WL 5372768 at *6. Distributors, for example, certainly intend to distribute pharmaceutical products, but that does not mean that they intend to cause any injuries resulting from later abuse of the products. The court in JM Smith found that the “conduct of distributing prescription drugs based upon orders placed by pharmacies is not, in and of itself, illegal and the violation of laws cannot be reasonably anticipated.” Id. In affirming, the Fourth Circuit explained that “[n]o defendant, and certainly not the insured, has been accused of providing prescription drugs to any person or entity knowing it was enabling an abuser.” JM Smith, 602 Fed. Appx. at 121.

In Richie Enterprises, for example, the court held that “allegations of negligent conduct in the complaint support a decision that the alleged prescription drug abuse epidemic is fortuitous since its creation was beyond Richie’s control.” 2014 WL 838768 at *7. The court explained that “the alleged harm is the prescription drug abuse epidemic in West Virginia, and its creation extended beyond Richie’s control. The pharmacies in West Virginia

Likewise, in H. D. Smith, the court found that “[t]wo of the eight counts [in the underlying opioid lawsuit complaint] specifically assert negligence. Other counts included allegations of both negligent and intentional conduct.

Given that it must liberally construe the allegations of

Occurrence The term “occurrence” is typically defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”

Insurers have argued that the opioid lawsuits allege intentional, not “accidental,” conduct because manufacturers and distributors

2019 Corporate Policyholder | 5

the underlying complaint, the Court concluded that H.D. Smith alleged an ‘occurrence.’”1 2015 WL 4624734 at *5.

The few courts that have accepted insurers’ “occurrence” arguments have done so on state-specific grounds or due to specific allegations in the underlying complaint at issue. See, e.g., Travelers Prop. Cas. Co. of America v. Actavis, Inc. (2017) 16 Cal. App. 5th 1026, petition for review conditionally granted, 229 Cal. Rptr. 3d 2 (2018).

In Actavis, the court held that the specific underlying lawsuits brought in California and Chicago did not allege an “occurrence” because they did not contain any allegations of negligence or raise the possibility that the insured could be liable based on a finding of negligence.

The California court also reached this result because,

are seeking damages for economic harm. Insurers often attempt to present their economic harm argument as if it is an actual policy exclusion or an ironclad rule of law.

It is neither. In fact, most CGL policies contain language stating that covered “bodily injury” can include “damages claimed by any person or organization for care...resulting... from the bodily injury.” Typically, this is precisely the type of damages the plaintiffs in opioid lawsuits are seeking: costs allegedly incurred to care for individuals who have been injured as a result of opioid abuse. Thus, these socalled economic damages are expressly covered by CGL policies. For this reason, the Seventh Circuit in H. D. Smith rejected one insurer’s economic harm argument and held that the insurer was required to provide a defense to a pharmaceutical distributor. 829 F.3d 771.2

under California law (at least at the time), if the insured intended the acts that resulted in injury, the event could not be considered an accident even if the insured did not intend to cause the injury. In other states, by contrast, a deliberate act can be considered an accident for purposes of the “occurrence” definition if the insured did not intend to cause the resulting injury. See, e.g., AutoOwners Ins. Co. v. Harvey, 842 N.E.2d 1279 (Ind. 2006).

On February 21, 2018, the California Supreme Court conditionally granted a petition for review of the Actavis decision. Its review was held in abeyance pending a decision in Liberty Surplus Ins. Corp. v. Ledesma & Meyer Constr. Co., Inc., a case the California Supreme Court already had accepted for review that was expected to address the interpretation of the term “occurrence” under California law. The California Supreme Court held in Ledesma & Meyer that a claim of negligent hiring, retention or supervision against an insured employer alleges a covered “occurrence,” even though the injury-causing conduct by the employee (in that case, molestation of a minor) was intentional. Liberty Surplus Ins. Corp. v. Ledesma & Meyer Constr. Co., Inc. (2018) 233 Cal. Rptr. 3d 487. This result could mean that the California Supreme Court will reach a different result in Actavis than the Court of Appeals did, although that remains to be seen.

Damages Because of Bodily Injury Insurers also have tried to avoid coverage by claiming that the underlying plaintiffs in the opioid lawsuits are not seeking damages “because of bodily injury” but, rather,

1 2

The same arguments have been made by insurers in lawsuits against firearm manufacturers brought by municipalities alleging increased costs as a result of the manufacturers’ negligence. These suits also alleged as damages the increased cost of police services, emergency services, medical care, social services and rehab/correctional services, as well as the loss of tax revenue. Courts, again, have largely rejected insurers’ assertions that they had no duty to defend because the underlying allegations were for economic losses. See, e.g., SIG Arms Inc. v. Employers Ins. of Wausau, 122 F. Supp.

2d 255, 260 (D.N.H. 2000) (finding that the underlying suit alleged damages because of bodily injury: “The plain meaning of the provision is to provide coverage when a claim is made, as in the underlying lawsuits here, seeking the costs of providing care for shooting victims and for the loss of their services”); Scottsdale Ins. Co. v. Nat’l Shooting Sports Found., Inc., 226 F.3d 642 (5th Cir. 2000) (affirming finding that the insurer had a duty to defend the underlying suit brought by City of New Orleans against the firearms trade association: “The complaint alleges that because of the bodily injuries to its citizens, the City of New Orleans had to incur additional costs. This allegation is arguably covered by the policies”).

These decisions collectively demonstrate a willingness on the part of most courts to impose a duty to defend on CGL carriers where public entities sue manufacturers and distributors of opioids for damages flowing from bodily injuries to members of the public served by these entities.

Depending on the nature of the underlying allegations, D&O carriers may contend that coverage is barred by exclusions for claims alleging bodily injury. This may place D&O and CGL carriers at odds on the issue of whether the underlying lawsuits involve claims for or because of bodily injury. It certainly is possible that an insured could have coverage under both its CGL and D&O/E&O policies and should examine and, if appropriate, pursue both avenues of coverage.

Triggering D&O and E&O Policies

Considering Other Issues

D&O and E&O policies are fairly broad and may provide coverage for economic damages claims in opioid lawsuits – which CGL insurers reject because they are not “because of bodily injury” – depending on the policy language and underlying allegations. Both types of policies generally cover economic losses an insured incurs as a result of a claim made against it for a “wrongful act,” typically defined to include an actual or alleged act, error, misstatement, misleading statement, omission, neglect or breach of duty that occurs within the course of managing a company (D&O) or performing professional services (E&O). To date, there have been no broadly applicable judicial decisions addressing the scope of D&O or E&O coverage that might be available for opioid claims. Policyholders nevertheless should keep these policies in mind when surveying their programs for potential coverage.

Once an insurer agrees to defend its insured, the complex coverage issues don’t stop. In fact, the issues may become more complicated. For example, battles can ensue between the insurer and its insured over which party gets to choose defense counsel and/or defense counsel’s rates. Disputes also arise over whether, when and for how much to settle the underlying lawsuit, and the amount. Consulting coverage counsel can help level the playing field when insurance companies aggressively attempt to avoid covering the enormous exposure to corporate policyholders presented by opioid litigation.

Travelers Prop. Cas. Co. of America v. Anda, Inc., 90 F. Supp. 3d 1308 (S.D. Fla. 2015), aff’d, 658 Fed. Appx. 955 (11th Cir. 2016).

The few other decisions addressing this issue in the opioid context offer far less insight about coverage for economic damages than the Seventh Circuit’s decision in H.D. Smith.

For example, one federal court accepted an economic harm argument but devoted little analysis to the issue, focusing instead on unique policy exclusions that precluded coverage for an opioid complaint.

In this case, Barnes & Thornburg represented the successful policyholder.

The successful policyholder was represented by Barnes & Thornburg.

6 | btlaw.com

2019 Corporate Policyholder | 7

INSIDE AN INSURANCE COMPANY HOW THEY WORK AND WHAT DRIVES THEM

By Jim Leonard

How Do Insurance Companies Operate?

Insurance companies are generally organized in five broad departments: claims, finance, legal, marketing and underwriting. Marketing and underwriting are the “yes” departments, while claims and finance are the

“no” departments. The legal department is often the referee between these competing interests. Underwriters seek to develop insurance products that can be sold to their customers for a profit. Though many standard insurance policies are made up of form documents, most underwriting departments will craft their own collection of forms and endorsements to provide the marketing department with the ability to say yes to customers and potential customers. While the underwriting and marketing departments want to sign up as many insureds as possible to collect premiums,1 the claims department manages claims when an insured seeks to recover on its insurance assets.

1 Our group euphemistically refers to insurance companies as “premium collection companies,” as insurers are typically very efficient when it comes to collecting premiums, but not nearly so when it comes to paying claims.

The underwriting department will say that it has no effect on a decision to pay a claim, but this is not always so.

When accommodation on a claim is requested by a good customer, or by a broker that brings the carrier a lot of business, the underwriting and marketing departments will sometimes intercede with the claims department.

The marketing and underwriting departments are judged by their premium collections and retention ratios (i.e., the percentage of insureds who renew their policies with that insurer), while the claims department is judged by how little it incurs resolving claims. Thus, there is an inherent and perpetual tension among these departments.

These financial measures drive insurance company management and profits, as well as the bonuses paid to department management.

How Do Insurance Companies Make Money?

Quite succinctly, there are only three ways that an insurance company can make money: (1) underwriting profit; (2) investments; and (3) reduced overall claims expense. Examining each of these potential profit centers helps to explain insurer motivation in claims handling.

An underwriting profit occurs when an insurance company insures policyholders who have few or no losses. By insuring these “good risks,” the insurance company takes in premiums but does not have to shell out any money for claims. If the underwriting department has done its job, it has carefully underwritten potential insureds for risk profiles that are favorable to the insurance company’s complex underwriting models.

These models typically contain numerous complex factors about the type of business or service provided, number of locations and employees, historic loss patterns, future anticipated claim trends and a variety

of nuanced categories that are unique to each insurer.2 When underwriting standards become lax – as they did in the early 1980s, with many commercial liability insurers who later became insolvent as a result – the ultimate losses that pour in wipe away any underwriting profit and result in underwriting losses. While risk evaluation and product pricing are carefully regulated by state insurance commissioners, whether an insurance company can generate an underwriting profit is to a certain extent beyond its control because of the fortuitous nature of losses and the continuous expansion and creativity of the plaintiff’s bar.

Investment income, like underwriting profits, is also largely beyond the control of the insurance companies. Insurers are scrutinized with respect to their investment portfolios.

State laws and the National Association of Insurance Commissioners (NAIC) regulate total percentages of stock market and other riskier investments in which an insurance company may invest. Because the financial security of insurers is one of the paramount goals of insurance commissioners around the country (as no one wants another AIG bailout), insurers simply are not permitted to invest anything but a small percentage of portfolios in high-risk/high-reward investments. Most of the insurance company portfolio investments include bonds, short-term and other low-yield but “safe” investing vehicles. Insurance company investments are supposed to be boring and ultimately safe for the insurance company and its investors and policyholders.

Reduced overall claims expense is the third and final method by which an insurance company can generate a profit. Notably, of the three factors, managing claims expense is the only factor that is considerably within the control of the insurance company. Keep in mind that the insurance industry is the largest legalized gambling industry in the world.3 The nature of insurance is, at its core, pure gambling. Insurance companies “bet” that their underwritten insureds will not have losses. Premiums essentially are set on the basis of: “I’ll bet you don’t have 2 Important factors in calculating an insurer’s potential underwriting profit are the cost and recoverability from reinsurance. Because reinsurance is a complex subject that could be the sole topic of this magazine, suffice it to say that virtually every insurer has reinsurance treaties with other insurance companies who insure the risks of the ceding insurer. By insuring their losses through reinsurance, insurance companies can temper their annual losses with reinsurance recoveries. Like all other insurance, reinsurance carries premiums which must be factored into the insurance companies’ profit margins and their risks on various lines of business.

The concept of insurance began at a public house in London operated by a British fellow named Lloyd who began gambling on whether or not ships sailing to the New World would return in one piece. This gambling enterprise eventually morphed into Lloyd’s of London and has become an immense insurance market in the ensuing 300 years.

3

8 | btlaw.com

2019 Corporate Policyholder | 9

a loss this year” or “I’ll bet you have only .001 losses this year.” The actuaries within insurance companies are the oddsmakers. The claims department can be seen as the leg-breakers in this gambling enterprise as they are the insurance company’s enforcer. The insureds pay their premiums and demand that the insurance company meet its obligations when a claim is submitted. The claims department then plays the odds by stiff-arming insureds whenever possible.

Think about it from the insurance company’s viewpoint: If it receives 10 claims and denies all of them, about six of those 10 insureds will simply go away. Of the remaining four insureds, perhaps two will push back and the insurance company will pay dimes on the dollar to negotiate a resolution. The remaining two intrepid policyholders who pursue coverage through litigation will often recover the most; however, the insurance company has succeeded in reducing its overall claims expense by starting out with routine denials of all claims – just by playing the odds. By employing aggressive defense tactics in claims handling and litigation management, the insurance companies increase their chances of an insured abandoning its claim due to cost or frustration and thereby increasing the insurer’s profits.

This is unfortunately the model that most insurance companies are built upon. And because overall claims management is viewed as the only profit factor that is in the control of the insurance company, senior management typically pays close attention to how aggressively their claims department handles policyholder claims. One or two out of 10 claims going into coverage litigation might be acceptable, but certainly eight or nine out of 10 would be unacceptable and would dramatically impact the insurer’s profits. But if an insurer’s “overexuberant” claims management tactics lead to negative regulatory attention, this can not only result in an impact on profits but also cause dramatic tension between underwriting and claims department management.

What Do Insurance Regulators Really Do? As noted above, insurance companies want to avoid close regulatory scrutiny. Of course, every insurance company is regulated by the insurance department of the state where the insurance company is domiciled. Typically, insurers undergo a triennial examination by the domiciliary insurance commissioner’s office. Auditors are sent to the claims office to examine individual claim files and inspect the insurance company’s books, and regulators 10 | btlaw.com

often interview senior management. State insurance departments want to know who is in charge of their regulated insurers and thus require sworn questionnaires be filled out by all of the insurance company officers and directors, which is also the case when insurance companies seek to become admitted carriers in other states in addition to where they are domiciled.

For very large commercial insurers doing business in multiple states, the underwriting department (which is typically responsible for regulatory compliance along with the finance department) tries to maintain excellent relationships with the insurance regulators who are responsible for its well-being. In fact, the primary job of insurance regulators is to review and confirm that insurance companies are solvent. This is the overarching goal of insurance commissioners around the country, and many of the NAIC rules and model regulations revolve around financial solvency.

The reality is that most insurance commissioners care less about how an insurance company is treating its insureds than about how solvent the insurance company is. In rare instances, the claims handling is so bad and the number of state insurance department complaints so high that the regulators will become involved. Typically, though, the state insurance departments will take a light hand when it comes to second-guessing insurance company claims decisions.

This often leaves the policyholder to fend for itself when a claim is wrongfully denied by an insurance company since the regulators are essentially rooting for insurance companies to succeed financially. This delicate balance between financial oversight and claims management can put the state insurance commissioners in a difficult position because they are usually elected officials who must answer to their policyholder constituents as well as their regulated insurance companies.

This delicate balance between financial oversight and claims management can put the state insurance commissioners in a difficult position...

One aspect of claims handling is carefully reviewed by insurance regulators: claims reserving. Insurance companies are required to post a financial reserve for every open claim within six months of the date of report (this can vary somewhat but is fairly standard within the industry). The insurer is required to evaluate its exposure on any given claim and set aside a financial reserve to cover the amount it believes represents its likely exposure on the claim. Because some claims are not developed at all within six months, this can become a guessing game based on the experience level of the individual claims representative handling the matter.

However, claims department management (typically a claims director or claims vice president) will review all recommended reserves and finalize or accept those reserve recommendations in the claims system.

If a claims representative’s reserves are consistently inadequate (or excessive), that claims representative will be counseled and often terminated if not following the claims department procedures for setting reserves.

Because this is one of the most important functions that the claims department carries out for the organization – and relates directly to financial solvency – insurance regulators will carefully review claims department reserving methodologies, history and sufficiency when reviewing the insurance company’s performance at the triennial examination.

How is the Claims Department Organized?

While there is no single answer to this question, most claims departments are organized as follows: claims vice president, claims director, claims manager(s) and claims representatives. There are also claims technicians who are the individuals receiving initial notices of claims and who manually set up a claim file in hard copy form (if still utilized by an insurance company) and in their computer systems. Most insurance companies have a dedicated claims system that is used for recording claims activity, as well as for documenting decisions about coverage and defense, reserve information and background information on the claim. This is the system that insurance regulators typically review to obtain the necessary information for their purposes. However, claims departments also use email to convey information and may have a third system called claim notes on a different server that captures routine claims activity as well.

be in place at any given insurance company and demand production of all such information (which some carriers can sometimes “forget” to produce). The insurer may omit the internal claim file notes required by regulators from its production of claim documents. Pressing for these notes can help demonstrate contradictions between the claims representative’s candid views of the claim entered in the system and the insurer’s formal coverage position addressed to the insured and to the court. In order to discover the information found under the claims department rocks, one must first know what the rocks look like.

Conclusion Knowing and understanding the minds of the claims department employees (from junior claims representative to senior vice president) and recognizing how those personalities can clash with the underwriting and marketing departments provides an avenue for the policyholder to exploit the weaknesses in the organization. Claims department senior managers have multiple forces pulling at them at all times – from regulatory to senior management of the company demanding lower claims expense and loss payments, to marketing management demanding payment of claims for good insureds, to the internal dynamics of a large claims department and the personality clashes that can ensue. Scrutiny of financial, underwriting, marketing and claims files can yield useful information in coverage litigation under a trained eye.

Thus, when litigating against an insurance company, it is vital to recognize all of the different systems that might 2019 Corporate Policyholder | 11

Compassion Sometimes Backfires:

Your company is aghast that by not firing Mrs. A 20

arose after the policy became effective.

loss caused by her at any time since then. According to the insurer, once your company learned of her prior dishonesty, crime coverage applicable to her subsequent conduct terminated automatically even though her prior misconduct was committed long ago. Is the insurer right

in accounting back to a position of responsibility. Her assistant begins training to replace her when she retires at the end of the year. As the assistant learns Mrs. A’s job, Your company prides itself on being a good place to

she notices a recurring payment to a vendor she does not

work, taking care of its employees and being a good

recognize: $7,500 a month for services the nature of which

corporate citizen. It provides generous employee

is unclear. The assistant calls the person listed as president

benefits. It has a wellness program. It matches 401k

of the company on its monthly invoice and speaks with a

contributions. It values its employees and lets them know

person who says that his company provides data security.

this in these and other ways.

The assistant goes to the IT department, which knows nothing about this vendor. Internal auditors get involved

So, when 10-year employee Mrs. A in accounting goes

and discover that the vendor is a shell that provides no

to human resources, says she is an alcoholic and needs

services to your company, and that the president is Mrs. A’s

help, and confesses to having stolen $5,000 from a

husband. When confronted, Mrs. A admits to having paid

dormant bank account to pay for her sick husband’s

the straw man vendor $7,500 per month over a 15-year

medical bills, your company responds with compassion.

period, thereby embezzling a total of $1.35 million.

Mrs. A is told that she must get treatment for her

She is immediately fired and the authorities are notified.

alcoholism and make restitution of the stolen money in

Mrs. A and her husband go to prison. None of the money

installment payments deducted from her paycheck. She

is recovered.

is removed from her supervisor position, her security clearance is taken away, and she is assigned to input

For many years, your company has purchased

data with no access to the general ledger. Mrs. A submits

commercial crime insurance covering losses resulting

a written apology, which is placed in her employee file.

from embezzlement by an employee. Your risk manager

She is told that any future violation of company rules will

submits a claim for the $1.35 million loss less the $10,000

result in termination.

deductible. The carrier denies the claim on the ground that coverage automatically terminated as to Mrs. A 20

Fast forward to 20 years later. Mrs. A is a model employee,

years ago when her $5,000 theft was discovered, citing

much loved by her colleagues. She has been promoted

the following provision of the policy:

12 | btlaw.com

used wording that clearly eliminates coverage for known

years ago, it appears to have lost its insurance for any

Automatic Termination of Commercial Crime Coverage Upon Discovery of an Employee’s Prior Dishonesty

By Bob Devetski

This insurance terminates as to any Employee as soon as the Insured’s Chief Executive Officer, Chief Financial Officer, Treasurer, Controller, Risk Manager, General Counsel or any person serving in a functionally equivalent position not in collusion with a perpetrator of a loss becomes aware of any criminal or dishonest act by such Employee while employed by or in the service of the Insured.

dishonest employees. The court pointed to a different case involving a Hartford policy that precluded coverage if the company “has knowledge” that the dishonest employee committed any dishonest act, “whether such act be committed before or after the date of the employment” by the company. The court stated that such policy language would clarify that the termination or exclusion of coverage relates back to any known employee who previously engaged in dishonest conduct, not just to conduct that

Travelers cited the many other cases decided in favor of the insurance company on similar facts and similar policy language, all based on the premise that as between the employer and the insurance company, the employer should bear the risk of employing a person with a known

about this?

prior record of dishonesty. Cooper Sportswear Mfg. Co.

As is always the case with insurance questions, the answer

Douglas Wilson & Co. v. Insurance Co. of N. America,

depends on the specific wording in the insurance policy.

v. Hartford Cas. Ins. Co., 818 F. Supp. 721 (D.N.J. 1993); Philadelphia, Pa., 590 F.2d 1275 (4th Cir. 1979). For

The policy language quoted above is the same as in a

example, in a more recent New York case, Capital Bank &

Wisconsin case with nearly identical facts. In Waupaca Northwoods LLC v. Travelers Casualty & Surety Co. of

a bank loan officer forged the name of the bank president

America, 2011 BL 109466 (E.D. Wisc. Apr. 25, 2011), the court held that Travelers owed coverage to its policyholder for a dishonest employee’s theft, even though the company had known of a prior act of dishonesty by that employee

Trust Co. v. Gulf Ins. Co., 91 A.D.3d 1251 (N.Y. App. Div. 2012), on loan documents in 2004 that led to the loss of $1.7 million. The bank timely submitted a claim to its insurer, Gulf, which denied the claim because the bank president had knowledge of prior forgeries by the same employee

before the Travelers policy was purchased.

three years before the bank reported the 2004 forgery.

The court pointed out that Travelers’ policy language

claim to its insurance company because he was the top-

focused on the present tense, rather than looking back to any time before the policy was issued. The policy says

The bank had not fired the loan officer or submitted a performing officer and the forgeries did not cause any loss to the bank.1 Gulf, however, denied the bank’s claim

the insurance “terminates” “as soon as” the company

based on its policy provision stating that:

“becomes aware of any dishonest” act. The court reasoned

Coverage terminates as to any employee as soon as the bank, or any director or officer not in collusion with such employee learns of any dishonest or fraudulent act committed by any such employee while employed by the bank.

that this use of present tense language suggests an awareness that is future-looking from the time of the policy’s purchase – and that if the company became aware of a dishonest act before the policy was issued, this termination clause would not be triggered. The court also said that because the policy speaks of coverage that

(Emphasis added.)

“terminates” rather than “excludes,” the policy must only be forward-looking since a policy could not “terminate” upon its very inception.

Finally, the court held that had Travelers wanted to

1 The forgeries involved underperforming loans, which were eventually collected.

exclude coverage for this situation, it could have easily

2019 Corporate Policyholder | 13

Despite the present tense wording of this policy, the New

by Travelers contain language broader in scope than the

York court enforced this provision and denied coverage

present tense language Travelers wrote into its policy.

to the bank, even though the bank president had learned of the employee’s dishonesty before the inception of the

In cases where the policy language clearly excluded or

policy. Contrary to the Wisconsin court in Waupaca, the

terminated coverage for dishonest employees whose

New York court in Capital Bank held that dishonest acts

past dishonesty was known to the company, coverage

committed by the employee, of which the bank was aware

was denied and the denial was upheld in court. But

before the policy began, terminated coverage as to that

where the policy language spoke in the present tense

employee immediately upon the policy’s inception.

and did not clearly say that knowledge of prior dishonest

PAST TENSE: How Insurance Companies Try to Use Past Events to Defeat Coverage of New Claims

acts that predated the policy would exclude coverage, While it may be hard to reconcile these two cases, the

the insurance company could not deny coverage for

New York court was not asked to consider the present

subsequent dishonest acts. Since insurance companies

tense of the policy language or what effect this had

write their own policies, they are free to write them

on its interpretation, because the bank did not make

in a manner that leaves no doubt about what they

this argument. Instead, the bank argued only that the

cover and do not cover. As the Wisconsin court ruled

employee’s act in 2001 did not rise to the level of a

in Waupaca, they must use language that makes their

“dishonest or fraudulent act” because the insured had

intent to terminate coverage upon pre-policy discovery

Liability insurance policies tend to fall into one of two

suffered no loss. The court held that sustaining a loss was

of employee dishonesty clear to the policyholder, or risk

categories based on the trigger of coverage: occurrence

not a required part of the termination provision – it applied

rejection of this coverage defense.

and claims-made policies. Generally speaking, under an

By John L. Corbett

occurrence policy, coverage is triggered if the underlying

upon prior discovery of dishonesty, regardless of whether The unfortunate reality exposed by this situation, and

accident (i.e., the “occurrence”) for which a party seeks to

the uncertainty it creates about whether your company

hold the policyholder liable takes place while the policy

The New York court was also swayed by the policy’s prior

has crime coverage for its $1.35 million loss in the above

is in effect, regardless of when the subsequent claim is

knowledge exclusion, which eliminated coverage for a

example, is that showing compassion for a dishonest

made. In contrast, under a claims-made policy, coverage

loss arising out of or in connection with any circumstances

employee – no matter how justified or consistent with your

is triggered if a claim (usually defined as a written demand

or occurrences known to the bank prior to the inception

corporate culture – puts your company at considerable

for relief) against the policyholder is first made and

of the policy. In this provision, there is a clear reference

risk. Long experience with crime claims teaches that

reported to the insurance company during the policy

to acts which occur before the inception of the policy.

dishonest employees, when discovered and forgiven,

period, regardless of when the underlying “wrongful acts”

Thus, the court was not required to address any present

often strike again. Crime insurers know this too; hence the

that gave rise to the claim took place.

tense confusion created by the termination provision – the

automatic termination provision cutting off coverage for a

insured’s prior knowledge of the employee’s dishonesty

dishonest employee once any bad act is discovered, no

Armed with this generalized understanding of how claims-

was enough to rule out coverage.

matter how long ago.

made policies operate, a policyholder may be lulled into

the dishonesty led to a loss.

The two cases Travelers cited in Waupaca in its effort to persuade the Wisconsin court to uphold its automatic termination provision were about policies with key differences in language. In Cooper Sportswear, supra, the Hartford policy excluded coverage for employees who committed a prior dishonest act “whether such act be committed before or after the date of employment by the Insured.” Likewise, in Douglas Wilson & Co., supra,

The only way to eliminate this risk is to fire any employee discovered to have committed any dishonest act, even one resulting in only a small loss, or even no loss at all. If a company does not do this, the risk of a subsequent embezzlement by the same employee, and the likelihood of a fight with its crime carrier over coverage for the new loss, rise exponentially.

thinking that, once a claim has been made and properly reported to the insurance company during the policy period, the timing of events before the policy period will have little if any impact on coverage.

This could be a dangerous assumption. Insurance companies frequently reserve the right to deny – or deny outright – coverage of claims made during the policy period on the basis of provisions in their policies that

another Hartford policy excluded coverage for dishonest

pertain in one way or another to events predating the

acts by employees who had committed a prior dishonest

policy period. Understanding some of the more common

act “in the service of the Insured or otherwise.” Both cases

ways insurance companies try to do this can forewarn

involve policy language that focused not just on acts of

and forearm corporate policyholders in their efforts to

which the company becomes aware in the future, but on

overcome these arguments.

acts committed prior to the inception of the policy as well.

As such, the policy provisions at issue in the cases cited

14 | btlaw.com

2019 Corporate Policyholder | 15

Retroactive Date Exclusions. Even if the

policyholders should carefully note the extent

control group had no knowledge of facts

of the delta between the retroactive date and

or circumstances that could give rise to

inception of the policy period in assessing the

a claim, rendering the prior knowledge

relative value of the proposed coverage.

exclusion inapplicable, this does not mean the policyholder is in the clear. Claims-

Corporate policyholders should also be on

made policies also contain retroactive

the lookout for insurance programs that

Prior Knowledge Exclusions. When a new claim is

foreseen that a claim might be made. See, e.g., Selko v.

date exclusions (also known as continuity

contain inconsistent retroactive dates. Many

reported to an insurance company, one of the first things

Home Ins. Co., 139 F.3d 146 (3d Cir. 1998); Cohen-Esrey

date exclusions) that apply based on when

corporations have primary policies and several

the company does is request information and documents

Real Estate Servs. v. Twin City Fire Ins. Co., 636 F.3d 1300

the underlying wrongful acts took place,

layers of excess insurance issued by different

regarding the factual background of the claim. While the

(10th Cir. 2011). Because the “objective” standard applies

regardless of whether anyone knew they

insurance companies. Occasionally, an excess

purpose of this request is usually characterized as helping

under these forms of prior knowledge exclusions, the fact

could form the basis of a claim. This is why

carrier will add a retroactive date to its policy

the insurance company defend against the claim, the

that a particular insured did not subjectively interpret the

it is incorrect to say that the timing of the

that does not match what the other carriers in

company often has an ulterior motive – to determine who

facts as posing a threat of a claim may not be a defense

underlying events is irrelevant to coverage

the program have added to their policies. In

was in a position to anticipate the claim for the purpose of

against application of the exclusion.

under a claims-made policy, even if the

circumstances where the underlying events

coverage trigger is the claim itself.

first took place after some of the retroactive

applying the policy’s prior knowledge exclusion.

Some variations of the prior knowledge exclusion can Because claims-made policies vary from carrier to carrier,

have a significant impact on coverage. For example,

there is no standardized prior knowledge exclusion. In

while many versions of the exclusion apply if the control

some instances, the provision is not even written as an

group member knew of facts that “could” or “might” lead

exclusion, but rather as a specified failure of a condition

to a claim, other versions require that the facts known be

precedent to coverage. Most variants of this exclusion,

“likely” to give rise to a claim. Under the latter standard,

however, provide that coverage of a claim is defeated

the insurance company has a heavier burden of showing

if any member of the corporation’s control group,

that the exclusion applies because it would have to

before a specific date in the past, knew or could have

demonstrate that the potential for a claim was relatively

reasonably foreseen that the wrongful acts at issue might

clear based on the individual’s knowledge.

dates, but before other retroactive dates, the Under many forms of the retroactive date

policyholder may be left with critical gaps in

exclusion, there is no coverage for claims

insurance coverage that leave its program

arising out of any related or continuing acts,

resembling Swiss cheese.

errors or omissions where the first such act, error or omission was committed or

The policyholder’s options in such

occurred prior to the retroactive date. As

circumstances are not pretty. It may have to

with prior knowledge exclusions, the timing

pay loss in the non-covered layer out of its

of the retroactive date may make or break

own funds. However, if the excess policies

coverage. Corporations that seek to minimize

contain language requiring that all underlying

their premiums can wind up with policies

limits be paid only by the carriers themselves,

containing extremely recent retroactive

in some states the policyholder may not be

dates. It is not unheard of for policies to be

able to pay the gap with its own funds, and it

issued with the inception date of the policy

could lose coverage in excess of that layer.

as the retroactive date – which leaves the

The bottom line is that policyholders need

policyholder with no coverage for most

to carefully review their liability insurance

date can create the risk of a challenge to coverage for

claims that are likely to be made against it

programs to ensure that these seemingly

when purchasing coverage to make sure that these

an otherwise-covered claim based on this exclusion. A

since claims are often made long after the

innocuous variations between the coverage

individuals are in a position to ensure that circumstances

far safer proposition from a coverage perspective is to

underlying events. When buying a policy, the

layers get ironed out.

that may lead to claims are properly conveyed to the

purchase a policy with a prior knowledge date at least

broker or insurer. Most claims-made policies provide

six months to a year before the policy period. Often,

that the policyholder may notice circumstances that may

insurance companies will preserve

lead to a claim and that, if those circumstances later do

the same prior knowledge date

lead to a claim, the claim will be deemed made when

in successive renewal policies

the notice of circumstances was initially provided to the

issued to the policyholder. This

insurance company.

means that the threat to coverage

be expected to form the basis of a claim. The definition of the control group varies from policy to policy, but

The date by which the prior knowledge exclusion

frequently encompasses the corporation’s CEO, CFO,

applies is also of great importance. Many policies

general counsel and risk manager. Sometimes, the policy

set the prior knowledge date at the beginning of the

may broadly define the control group to include any

policy period. Because the policyholder sometimes

officer, director or corporate counsel.

knows facts surrounding or signaling a future claim, purchasing a policy with so recent a prior knowledge

Policyholders should review these definitions carefully

presented by the prior knowledge The majority of courts construing the most common

exclusion diminishes over the

forms of prior knowledge exclusions have held that they

period of the relationship between

apply if (1) a member of the specified control group had

the policyholder and the insurance

knowledge of certain facts prior to the specified date,

company.

Corporations that seek to minimize their premiums can wind up with policies containing extremely recent retroactive dates.

It is not unheard of for policies to be issued with the inception date of the policy as the retroactive date – which leaves the policyholder with no coverage for most claims that are likely to be made against it since claims are often made long after the underlying events.

and (2) a reasonable person in that position could have

16 | btlaw.com

2019 Corporate Policyholder | 17

Rescission. Even if no exclusion in the policy applies

Because rescission can lead to costly and fact-intensive

to the claim, the insurance company may try to get out

litigation, carriers have begun issuing non-rescindable

of coverage by rescinding the policy on the basis of

policies with a new exclusion applicable in the event

omissions or misrepresentations in the application for the

of omissions or misstatements on the application.

policy. Many states have statutes or case law that permit

Instead of retaining the right to rescind policies based

an insurer to rescind a policy – that is, treat matters as if

on policyholder omissions and misstatements, non-

the policy had never existed – where the policy is issued

rescindable policies contain an exclusion under which the

on the basis of a material omission or misstatement by

carrier can deny coverage for any claims arising out of

the policyholder.

facts that were material to the carrier’s assumption of the risk where those facts were omitted or misrepresented on

For example, assume that the insurance company has

the policy application.

issued a series of renewal policies to the policyholder,

18 | btlaw.com

such that the prior knowledge date is now several years

While this is not an optimal solution for policyholders, such exclusions may prove valuable where the policyholder’s

Prior and pending litigation exclusions.

by the policyholder during the policy period.

in the past, and the prior knowledge exclusion is not

Related to retroactive date exclusions are

The law permits qui tam actions to be kept

applicable to the control group’s knowledge of more

risk profile contains numerous risks, only one of which may

what are known as prior and pending litigation

under seal for a period of time, during which

recent wrongful acts that preceded the policy or the

be excluded under the policy. It goes without saying that,

exclusions. For example, a claims-made

the defendant has no legal way of knowing

claim. The insurance company, realizing it cannot point

to avoid any potential loss of coverage – whether through

policy may contain an exclusion precluding

it is a party to a legal proceeding. At least

to any applicable policy exclusion, may closely scrutinize

rescission or the newer exclusion – it is imperative

coverage for claims arising out of any litigation

one authority has held that qui tam actions

the renewal application for any questions that reasonably

that the policyholder consider carefully reviewing its

filed or commenced on or before the pending

brought before the prior and pending litigation

called for the policyholder to disclose information about

application to ensure it has responded to the questions

litigation date. In many ways, this exclusion is

date, but not unsealed until after that date, can

the circumstances leading to the claim. If it finds such

as fully as possible.

similar to a retroactive date exclusion in that

trigger a prior and pending litigation exclusion

a question, and the policyholder did not disclose that

it can give a carrier an argument for denying

because the text of the exclusion does not

information in response, the carrier may seek to rescind

coverage based on the timing of underlying

require that the policyholder have knowledge

the policy, particularly if the claim has substantial value,

events on which the present claim is based.

of the litigation. See AmerisourceBergen

or the underlying facts may lead to a series of claims

Corp. v. Ace Am. Ins. Co., 100 A.3d 283 (Pa.

against the policyholder over time. Generally, if the

Some prior and pending litigation exclusions,

Super. 2014). To avoid a counterintuitive –

insurer successfully rescinds its policy, it owes nothing

however, are written in such a way that, under

and demonstrably unfair – result like this,

more than the return of the premium payment to the

certain circumstances, they can defeat the

policyholders should make it part of their

erstwhile policyholder.

policyholder’s ability to obtain coverage of

policy review to ensure that, if their policy

the claim under any claims-made policy.

must have a prior and pending litigation

In most states, a misrepresentation in insurance

For example, assume that the policyholder

exclusion, it is written in such a way that it only

application warranting rescission of the policy must

was, prior to the policy period and the prior

applies to litigation of which the policyholder

not only be material, it must also be intentional and

and pending litigation date, sued in a qui

has notice.

fraudulent. In these states, mere mistakes are not

tam action under the federal False Claims

grounds for rescission. In a minority of states, such

Act – that is, an action brought by a private

as California, even an innocent factual mistake in the

citizen “whistleblower” on behalf of the

application is enough to justify rescission of the resulting

government – and that this qui tam action is

policy. No matter what state’s law applies, it pays to get

factually related to a claim made and reported

the facts right in the application.

2019 Corporate Policyholder | 19

CASE SUMMARIES STAYING UP TO DATE ON INSURANCE POLICY LAW IS CRITICAL. HERE ARE A FEW SIGNIFICANT INSURANCE CASES DECIDED RECENTLY.

By Abby Vineyard

Court Provides Context for How Policyholder’s Alleged Intent Affects Coverage Office Depot, Inc. v. AIG Specialty Insurance Co., 722 F. App’x 745 (9th Cir. 2018) Section 533 of the California Insurance Code prohibits insurers from indemnifying the policyholder for his or her willful conduct and is treated as an implied exclusion in all policies under California law. The U.S. Court of Appeals for the Ninth Circuit’s recent decision in Office Depot helped place limits on an insurance company’s ability to use this statute to deny coverage.

The underlying claimant in Office Depot alleged that the policyholder violated the California False Claims Act (CFCA) in connection with unfulfilled pricing promises to various public agencies. The insurance company denied coverage of the policyholder’s defense costs and settlement of those claims. In the ensuing coverage litigation, the lower court held that, because liability under the CFCA requires a finding of willful conduct, Section 533 applied to defeat coverage of the policyholder’s liability for the CFCA claims.

The Ninth Circuit reversed the lower court, concluding that, as a matter of law, the CFCA does not necessarily require proof of specific intent to defraud but, instead, only requires proof of “recklessness” as to the truth or falsity of the information at issue. Because Section 533 is an “exclusionary clause,” the court noted that the carrier had the burden of proving that the CFCA claims fell within the clause. The court concluded that the carrier failed to meet its burden and remanded the case for the trial court’s consideration of the carrier’s alternative arguments relating to exclusions and the scope of coverage.

Insurance companies often use Section 533 as a bludgeon against policyholders when willful acts

20 | btlaw.com

are alleged. Office Depot demonstrates that subtle distinctions in the nature of the claimant’s theory of liability against the policyholder can be determinative of whether Section 533 applies to defeat coverage.

Policyholders Finally Get Relief in Computer Fraud Cases in Second Circuit Medidata Solutions Inc. v. Federal Insurance Co., 729 F. App’x 117 (2d Cir. 2018) The U.S. Court of Appeals for the Second Circuit recently affirmed a district court’s ruling that the policyholder’s $4.8 million loss resulting from a phishing email scam was covered by a commercial crime policy’s computer fraud coverage. The policyholder was deceived into wiring funds to a fraudulent overseas account by an email that appeared to come from the policyholder’s president. The carrier denied coverage, arguing that there had been no actual manipulation of the policyholder’s computers and the loss was not the result of a spoofing attack since the policyholder itself caused the funds to be transferred.

The Second Circuit disagreed, and concluded that the entry of data into the policyholder’s computer system constituted an attack and satisfied the computer fraud provision covering loss arising from the “entry of data” or “change to data elements” of a computer system. It also rejected the carrier’s causation argument, holding that the spoofing attack was the proximate cause of the policyholder’s loss, and the policyholder’s involvement in effectuating the transfer did not constitute an intervening event that broke the causal chain.

This is a significant decision because the Second Circuit is the first circuit to determine that losses caused by fraudulent business email schemes using a PHP script, a programming tool used by cyber criminals to send fake emails, constitute computer fraud under a crime policy.

It is an important victory for policyholders given the everincreasing rise of social engineering scams.

Policyholders May Recover Bad Faith Damages Even When No Finding of Carrier’s Breach of Contract USAA Texas Lloyds Co. v. Menchaca, 545 S.W.3d 479 (Tex. 2018) The Texas Supreme Court recently concluded that policyholders may, under certain circumstances, recover bad faith damages even when the carrier did not breach the policy. In April 2017, the trial court held that a policyholder could succeed in its claim against its carrier for damages arising out of the carrier’s violation of Texas’ bad faith practices statute, even though the carrier’s conduct did not actually breach any terms of the policy. The court explained, however, that the carrier could not be liable for extracontractual liability where the policyholder had no right to receive policy benefits and had not proved it suffered an independent injury. There was much confusion in the lower courts as to how these principles applied in practice, so the Supreme Court agreed to a rehearing and provided additional context in a new ruling issued in April 2018.

On rehearing, the court affirmed the general rule that a policyholder cannot recover extracontractual damages (such as bad faith damages) if the policy affords no coverage in the first place, but clarified that if a carrier wrongfully denies coverage or withholds benefits, the lost benefits themselves can serve as “actual damages” (instead of extracontractual damages) to support a bad faith claim, even if the policyholder does not pursue or recover on a breach of contract claim.

This means that policyholders need not prevail on a breach of contract theory of liability as a prerequisite to liability under the bad faith practices statute. This is a positive development for policyholders, but it bears noting that policyholders will likely still have an uphill battle when trying to recover in this manner: Recovery of bad faith damages without a finding of coverage still requires proof of either lost policy benefits or an independent injury.

Additional Insureds Are Cautioned to Read Endorsement Language Carefully Gilbane Building Co./TDX Construction Corp. v. St. Paul Fire and Marine Insurance Co., 97 N.E.3d 711 (N.Y. 2018) The New York Court of Appeals (that state’s highest court) recently answered the question of whether an additional insured must be in contractual privity with the named insured in order to be entitled to coverage, a question that had been met with divergent answers by lower courts. In Gilbane, the policyholder entered into a construction contract with a property owner that required the policyholder to name several other parties, including the plaintiff, as additional insureds on its policy.

The policy’s additional insured endorsement extended coverage to “any person or organization with whom you [the policyholder] have agreed to add as an additional insured by written contract.” The policyholder listed the plaintiff as an additional insured, but the carrier denied coverage on the grounds that there was no written contract between the policyholder and the plaintiff.

The putative additional insured argued that, despite the policy language, no written contract was necessary because such a requirement would conflict with the plain meaning of the endorsement, with the parties’ “reasonable expectations,” and with long-standing rules of policy interpretation. The court disagreed on the basis of its strict reading of the policy language. It concluded that the endorsement’s use of the word “with” made clear that there must be a written contract between the policyholder and the additional insured in particular – and not merely a contract between the policyholder and any party requiring additional insured coverage for the purported additional insured. This decision serves as a warning to parties seeking to add additional insureds to an insurance policy that they must carefully review the policy’s endorsement language to make sure their contractual arrangement closely follows the specific textual requirements of the endorsement.

2019 Corporate Policyholder | 21

RECOVERING CONSEQUENTIAL DAMAGES UNDER GENERAL LIABILITY POLICIES

By Charles P. Edwards and Alexandra R. French

were not “because of…property damage,” the court held that, “the event precipitating their legal action is contamination of property. The costs that result from such action are therefore incurred ‘because of’ property damage.” Id. at 842. A California Court of Appeals recently followed AIU in holding that certain delay damages were covered, holding that the “delay constitutes a consequential loss (a loss occasioned by the water intrusion) and as such, is part of the damages NAC must pay ‘because of’ property damage.” Global Modular, Inc. v. Kadena Pac., Inc., 15 Cal. App. 5th 127, 145, review den. (Dec. 13, 2017).

“for an economic loss, rather than for ‘property damage’ as defined in and covered under the policy.” Id., at *2.

The California Court of Appeals reversed, holding that the club’s loss of use as a nightclub constituted property damage and that the resulting diminished value of the club qualified as damages “because of” that property damage. The court went so far as to hold that it “defies common sense to argue otherwise.” Id., at *8. The court specifically distinguished the earlier California cases interpreting the older definition of property damage. Id., at *15-16.

Most of the California confusion stems from reliance on pre-1973 cases. In 1973, the definition of “property

An often-overlooked feature of commercial general liability (CGL) policies is that they provide coverage for damages the insured is legally obligated to pay “because of” bodily injury or property damage. Most courts interpret “because of” broadly to include consequential damages and other damages that, while not themselves property damage, are traceable to covered property damage. While consequential damages are less likely to result from bodily injury, the scope of coverage is the same.

The rule that the standard CGL language providing coverage for damages “because of” property damage includes consequential damages having a causal connection to covered property damage is followed by the majority of courts that have considered the question.

As one commentator has noted, “‘Because of’ can, and should, be read to mean: as a consequence of, on account of, or arising from. Certainly, this is the ordinary and usual meaning of ‘because of.’” Scott C. Turner, Insurance Coverage of Construction Disputes § 6:22 (2d ed.).

In Am. Home Assur. Co. v. Libbey-Owens-Ford Co., 786 F.2d 22 (1st Cir. 1986), for example, the court addressed the scope of coverage for damages arising from defective windows installed in the John Hancock office building in Boston.

The need to replace the windows resulted in various increased construction and operating costs and delayed the occupancy date from April 1, 1973, to June 1, 1975.

Hancock sued the window manufacturer, Libbey-OwensFord Company (LOF), and others to recover these damages, which included approximately $11 million for the costs of removing and replacing the windows and an additional approximately $88 million of consequential damages.

The First Circuit held that one reasonable interpretation of the “because of” language is that it “provides coverage not only for property damage, but also for consequential damages resulting from property damage.” Id. at 26.

The court further noted that, although the policy would expressly exclude coverage for the $11 million in costs

22 | btlaw.com

associated with the repair and replacement of LOF’s own product, the policy did not exclude Hancock’s consequential losses resulting from the breakage of LOF’s windows. Id. at 27. Accordingly, the court held, “[g]iven that American Home’s current policy is at best ambiguous, and at worst clearly applicable to cover LOF’s damages, we hold that the policy covers consequential losses stemming from physical injury to LOF’s products.”

Id. at 28.

Courts also have found coverage for economic losses

damage” in standard CGL language issued by

that arise “because of” bodily injury. In Cincinnati Ins.

the Insurance Services Office (ISO) was revised

Co. v. H. D. Smith, L.L.C., 829 F.3d 771, 774 (7th Cir.

to specifically include “loss of use of tangible

2016), for example, the court addressed coverage

property which has not been physically injured.”

for an underlying claim brought by the state of

The prior language had defined property damage

West Virginia against drug distributors for costs

as “physical injury to or destruction of tangible

incurred by the state as a result of its citizens’

property, including loss of its use.” See Gunderson

addiction to drugs supplied by those companies.

v. Fire Ins. Exch., 37 Cal. App. 4th 1106, 1115 (1995).

Id. at 773. The question presented was whether

Several courts had held that under this earlier

the costs incurred by West Virginia were

language, the loss of use referred only to property that was physically injured or destroyed. Id. The 1973 revision makes it clear that the loss of use of property which has not been physically injured also qualifies as property damage.

The California Court of Appeals recently clarified confusion in Thee

The First Circuit also cautioned the insurance industry that “an insurance company wishing to exclude consequential damages should use specific language to that effect.” Id. at 26. This caution was issued more than 30 years ago, and the “because of” language continues to appear on CGL policies without any specific exclusion for consequential damages.

Sombrero, Inc. v. Scottsdale Ins.

While the “because of” language is form language found in the vast majority of CGL policies, some states have interpreted the language more broadly than others. In some states, the case law is not necessarily uniform.

In California, for example, insurance companies often cite cases narrowly construing the language. But in AIU Ins. Co. v. Superior Court, 51 Cal.3d 807, 814 (1990), the California Supreme Court held that CGL policies cover the costs of reimbursing government agencies and complying with injunctions ordering cleanup under CERCLA, the Superfund statute, and similar statutes.

In rejecting the argument that these economic costs

a banquet hall. The owner sued its

Co., 2018 WL 5292072 (Cal. Ct. App. Oct. 25, 2018). The case involved a nightclub called El Sombrero that had its use permit modified after a fatal shooting so that it could be operated only as security service (CES) alleging that its negligence in allowing the shooting had caused economic damages to the club, including a diminution in the value of the club associated with the modified use permit. After obtaining a default judgment in the amount of the diminished value of the club, the club owner sued CES’s liability insurer (Scottsdale) for indemnity.

The trial court granted summary judgment for Scottsdale, holding that the club’s claims were

“because of” bodily injury. Id. at 774-75. The court held they were. Id. The court based its holding on its recognition that a CGL policy “cover[ing] suits seeking damages ‘because of bodily injury’...provides broader coverage than one that covers only damages ‘for bodily injury.’” Id. at 774 (original emphasis). The court illustrated the breadth of “because of” in the language at issue by giving the following example: [A]n individual has automobile insurance; the insured individual caused an accident in which another individual became paralyzed; the paralyzed individual sues the insured driver only for the cost of making his house wheelchair accessible, not for his physical injuries.

If the insured driver had a policy that only covered damages “for bodily injury” it would be reasonable to conclude that the damages sought in the example do not fall within the insurer’s duty. However, if the insurance contract provides for damages “because of bodily injury” then the insurer would have a duty to defend and indemnify in this situation.

2019 Corporate Policyholder | 23

Id. (quoting Medmarc Cas. Ins. Co. v. Avent Am., Inc., 612 F.3d 607, 616 (7th Cir. 2010)).

The types of consequential damages courts have held are covered by the standard “because of” language in CGL policies are various and extensive.

The Turner treatise, for example, lists the following: Construction delay and loss of use, liquidated damages for delay, construction impact (i.e., loss of worker efficiency in performing construction work), relocation and storage costs; temporary repairs, diminution in the value of property, later resulting physical injury to other tangible property, the cost to remove and reinstall (or replace) good work in order to access the property damage (often called “rip and tear” damage), the additional

repair and reconstruction costs required to bring the building into compliance with the current building code, loss or reduction of production, lost rents, lost profits, increased overhead, environmental response costs under CERCLA and similar statutes, costs incurred for mitigation or prevention of further property damage or bodily injuries, investigation and inspection costs, costs for clean-up and debris removal, costs of notifying adversely affected parties, the insured’s indemnity obligations to others (such as to the insured’s surety on a performance bond), loss of good will or damage to reputation, and emotional distress…

Turner, § 6:22.

The few courts that have upheld denials of coverage for consequential damages have often confused whether the claimed damages constituted property damage, with the operative question of whether the damages were because of property damage. See, e.g., Kvaerner N. Am. Constr. Inc. v. Certain Underwriters at Lloyd’s London Subscribing to Policy No. 509/DL486507, 2017

24 | btlaw.com

WL 2821691, at *9 (N.D.W. Va. June 28, 2017) (“liquidated damages still must fall under the CGL policy’s property damage definition”); St. Paul Fire & Marine Ins. Co. v. Amsoil, Inc., 51 F. App’x 602, 604 (8th Cir. 2002) (“economic loss which is not ‘property damage’ is not covered under a CGL policy”); Essex Ins. Co. v. Chem.

Formula, LLP, No. 1:CV-05-0364, 2006 WL 5720284, *6 (M.D. Pa. Apr. 7, 2006) (“loss of profits, damage to commercial reputation, and loss of goodwill are not tangible property damage as defined by the policy”).

Insurers often adopt this erroneous position in refusing to cover consequential damages.

The Ninth Circuit recently held that an award of attorneys’ fees to the prevailing plaintiff in an underlying lawsuit against a policyholder is covered under the policyholder’s CGL policy. Ass’n of Apartment Owners of Moorings, Inc. v. Dongbu Ins. Co., 731 F. App’x 713 (9th Cir. 2018) (construing Hawaii law). The court held that “in the context of the policy, the plain meaning of ‘damages’ encompasses the fees the Bradens incurred to vindicate their claim for water damage to their home, even if

court or jury in its role as the fact-finder. The scope of an

fact issue [exists] as to whether the reason at least some

insurance company’s indemnity obligation (as opposed to

of the post-crash emergency services were performed –

its duty to defend, which is broader) often is dependent

and potentially had to be performed – was bodily injury

on the outcome of the underlying case. See, e.g., United

sustained in the plane crash, or any and all claims related

Nat’l Ins. Co. v. Dunbar & Sullivan Dredging Co., 953 F.2d

to bodily injury.” Id. The court reversed the trial court’s

334, 338 (7th Cir. 1992) (“[T]he duty to indemnify must

summary judgment for Starr and remanded for further

await resolution of the underlying suits.”); Westfield Ins. Co.

proceedings, presumably a trial, on the question of which

v. Sheehan Const. Co., 575 F. Supp. 2d 956, 960 (S.D. Ind.

of the damages sought by Kenyon were “because of”

2006) (“The Plaintiff’s duty to indemnify will depend upon

bodily injury. Id.

the facts and outcome of the underlying Indiana state court action.”) Yet many courts deciding the coverage issue also have decided what damages they deem to be “because of” bodily injury or property damage, rather than leaving that issue for determination in the underlying case.

A recent case from Texas, however, separates the legal

Policyholders should consider it a best practice to scrutinize any argument by an insurance company that consequential damages are not covered because they are not bodily injury or property damage. Where those damages arise “because of” covered bodily injury or property damage, they may well be covered.

question of the meaning of “because of” from the factual question of what damages were “because of” bodily injury or property damage. See Kenyon Int’l. Emergency

those fees are not a measure of that physical damage.”

Id. The court also held that the attorney fee award was “because of” the covered property damage, holding “[t]his phrase, which is undefined, connotes a non-exacting causation requirement whereby any award of damages that flows from covered property damage is covered, unless otherwise excluded.” Id. Note, however, that other courts have concluded that an award of attorneys’ fees against the policyholder constitutes “costs” falling within an insurer’s defense obligation, rather than “damages” falling within its indemnity obligation. See, e.g., Prichard v. Liberty Mutual Ins. Co., 84 Cal. App. 4th 890, 911-912 (2000) (attorneys’ fees awarded against the policyholder fall within the scope of a carrier’s supplementary payments obligation because they are statutorily defined in California as costs, and therefore are not “damages” within the meaning of a CGL policy).

Srvs., Inc. v. Starr Indem. & Liab. Co., 2018 WL 3431853, at

One issue that has not been extensively litigated is

favorable to Kenyon, at least some of the damages

whether the determination of what damages are

Kenyon seeks may include sums Seaport became legally

“because of” bodily injury or property damage is a

obligated to pay because of bodily injury,” and, therefore,

question for the court as a matter of law, or one for the

covered by the policy. Id. at *4. The court then held that “a

*1 (Tex. App. July 17, 2018). The case involved coverage for emergency services performed by Kenyon for Seaport Airlines after the crash of a Seaport plane, which included setting up a call center, providing first responders and mental health staff, and establishing a welfare support line. Seaport’s aviation policy issued by Starr provided coverage for all sums that the insured shall become legally obligated to pay as damages “because of” bodily injury or property damage. After Seaport went bankrupt and failed to pay Kenyon for the services Kenyon performed after the crash, Kenyon sued Starr seeking a declaratory judgment that Starr’s policy covered the services and recovery in equitable subrogation.

The court first held that, “[v]iewed in the light most

2019 Corporate Policyholder | 25

whether and how the named storm deductible should be applied. For example, in Saratoga Resources, Inc. v. American Int’l Group, Inc., 102 F. Supp. 3d 915 (S.D. Tex. 2015), the parties disputed the amount of the applicable deductible and how the deductible policy provision should be interpreted in connection with damage to several of the insured’s oil and gas properties caused by Hurricane Isaac. The parties agreed that the hurricane was a named windstorm subject to the special deductible of “5% of Total Insurable Values at the time and place of the loss,” rather than the general deductible of $125,000. They also agreed that the hurricane was a single occurrence.

Do you know what your deductible will be when the

NEXT BIG STORM HITS?

By Jonathan Boustani

In 2017, 17 named storms hit the United States1 and caused $202.6 billion in damage.2 2018 has not been much better, with another 15 named storms exceeding $1 billion each across the United States.3 While the power outages and disaster relief efforts associated with these storms garner significant media attention, issues surrounding the insurance coverage for storm-related damage are also worthy of consideration.

When the dust settles after a major storm, a corporate policyholder often finds that it has suffered more than just property damage. The company may be harmed by the loss of utilities, road closures or other impediments in accessing their property, and even government curfews.

The ingress and egress provisions of a property policy may provide insurance coverage for these losses, but the manner in which the policy’s deductible applies to specific non-property losses is not always clear.

Many policies have a special deductible for a named storm, which is typically defined as any storm named by the National Weather Service. A named storm deductible usually applies to certain locations defined in the policy (typically places more prone to storms or with large amounts of insured inventory). It is also common for the amount of a named storm deductible to be calculated as a percentage of the amount of the insured

https://www.npr.org/sections/thetwo-way/2018/04/06/600193418/2018-hurricane-season-will-bring-another-battery-of-storms https://www.insurancejournal.com/news/national/2017/11/28/472368.htm 3 https://www.noaa.gov/media-release/destructive-2018-atlantic-hurricane-season-draws-to-end; https://www.ncdc.noaa.gov/billions/ 1

2

26 | btlaw.com

inventory at certain locations. Depending on the specific deductible language found in the policy and the size of the company, a named storm deductible can be very large and, thus, present a significant obstacle to recovery under the policy.

For example, assume a company has 10 locations impacted by a named storm with $1 million worth of inventory at each location. If each location is subject to a named storm deductible and that deductible is 5% of the total insured amount at each location, the company would be required to pay $500,000 of the loss before the insurer has to write a check for the rest. Assume further that the company’s business was interrupted by impediments to ingress and egress at each location, but the company did not suffer property damage. In that scenario, it is likely that, without property damage, the amount of loss susceptible to coverage will be lower and may not exceed the $500,000 named storm deductible.

When the size of the named storm deductible arguably limits coverage in this manner, the policyholder or its insurance carrier may initiate litigation to determine

However, the parties disagreed on the proper interpretation of the deductible provision, which provided in relevant part that “[i]f two or more deductible amounts apply to a single occurrence, the total to be deducted shall not exceed the largest deductible applicable.” According to the policyholder, this provision unambiguously indicated that the deductible amounts for each property were separate and that the applicable deductible was 5% of the total insured value of the most expensive property, i.e., $400,000. According to the carrier, however, that same provision unambiguously required the insured to pay 5% of the total insurable values of each damaged property added together, which amounted to $912,500.

The court ultimately agreed with the carrier, finding that the deductible language was not ambiguous when read in conjunction with the other policy language regarding the special deductible for named storms. Specifically, the court determined that (1) the policy language describing calculation of the special deductible – “5% of Total Insurable Values” (emphasis added) – indicated that more than one value and, thus, more than one property, was contemplated; and (2) the phrase “two or more deductible amounts” referred to different types of deductibles that might apply to same property – e.g., separate deductibles for fire damage or wind damage – as opposed to one type of deductible for different properties. As a result, the court held that the applicable deductible was 5% of the total, or sum, of the insurable values of each damaged property.

In El-Ad Enclave at Miramar Condo. Assoc., Inc. v. Mt. Hawley Ins. Co., 752 F. Supp. 2d 1282 (S.D. Fl. 2010), the court construed a similar windstorm deductible provision in favor of an insurance company, ruling that the provision was unambiguous as it applied to a loss caused by Hurricane Wilma. The court rejected the insured’s argument that the policy’s “peril deductible” of

2019 Corporate Policyholder | 27

“3.00% of total values at risk Per Building…at the time of loss” should be interpreted as 3% of the $1 million policy limit, or $30,000, determining that the parties would have used express language if they intended that a deductible be based on a fixed monetary sum per occurrence.

The court also rejected the insured’s contention that it would be unfair to calculate the deductible based on the values of each building at the time of loss because the deductible might exceed the policy limit, rendering the policy useless. Although the court acknowledged that the deductible was very high for the hurricane loss relative to the policy limit, it agreed with the insurance company that this would not always be the case under the policy. On this ground, the court held that the insurance company’s interpretation of the deductible provision was reasonable.

The court in AFP 104 Corp. v. Columbia Cas. Co., 2014 WL 793780 (D.N.J. Feb. 26, 2014) addressed a related issue. There, the insurance company moved to dismiss the policyholder’s complaint because the named storm deductible exceeded the claimed loss amount. The insured argued that its complaint sufficiently alleged that Hurricane Sandy was downgraded by the time it damaged the insured’s property, and that therefore the named storm deductible did not apply. The court denied the insurance company’s motion to dismiss on the ground that the insured had alleged a basis for recovery based on facts that, if true, would demonstrate that the insurance company’s application of the named storm deductible was improper. By this means, the court acknowledged that there are circumstances under which the meaning of the named storm deductible – and whether, once a named windstorm triggered the deductible, it applied even after the storm was no longer a hurricane – could be influenced by facts extrinsic to the policy.

by the hurricanes and, therefore, were subject to the higher deductible.

These cases illustrate the kinds of disputes that may arise over the interpretation and application of a named storm deductible where the policyholder has suffered significant storm damage to one or more covered properties.

Noting that the policy did not define “ensuing loss” and that neither party had identified any case law interpreting this phrase in connection with a policy deductible, the court found that this policy language was ambiguous.

Because the insured had had input in drafting the policy, the court did not automatically resolve the ambiguity in favor of the insured, and held that extrinsic evidence was needed to resolve the ambiguity at trial.

These cases illustrate the kinds of disputes that may arise over the interpretation and application of a named storm deductible where the policyholder has suffered significant storm damage to one or more covered properties. To avoid some of the pitfalls described in these cases, corporate policyholders should consider pushing for more favorable policy language at the outset.

For example, a policyholder might try to negotiate a cap

on the deductible in cases of severe storm damage so that the deductible would be less likely to approach the policy limits or exceed the actual loss suffered.

The simplest solution, but perhaps the most difficult to achieve, is to convince the carrier that the deductible should be calculated as a lower percentage of the value of the covered property.

Similarly, instead of calculating the deductible based on the same percentage of the value of the covered property regardless of the property’s value, the policyholder might negotiate a deductible scheme whereby the percentage of the covered property’s value used to calculate the deductible would decrease as the value of the covered property increased. In other words, the deductible for a high-value property would be calculated as a relatively low percentage of the property’s value (e.g., 2%) while the deductible for a lowvalue property would be calculated as a relatively high percentage of the property’s value (e.g., 5%).

Similarly, in RTG Furniture Corp. v. Indus. Risk Insurers, 616 F. Supp. 2d 1258 (S.D. Fl. 2008), the court addressed an “ensuing loss” exception to a policy’s named storm deductible provision. The exception provided that the named storm deductible did “not apply to ensuing loss or damage not otherwise excluded herein.” Accordingly, the insured argued that its business interruption losses – ingress and egress, interruption of power and utilities, acts of civil authority and damage to dependent property – were not subject to the named storm deductible because they “ensued” from Hurricanes Charley, Frances and Jeanne, and did not occur at store locations that sustained direct physical damage from the hurricanes. In opposition, the insurance company contended that the business interruption losses were not “ensuing” because they were not separate and distinct from the loss caused

28 | btlaw.com

2019 Corporate Policyholder | 29

Legal arguments for all sums stronger than pro rata: The policy says the insurance company will pay all sums

ALLOCATION OF

AMONG MULTIPLE POLICY PERIODS

clause of a standard policy, which before the late 1980s

become legally obligated to pay as damages…

covers only “those sums” – rather than “all sums” –

all sums which the insured shall become legally

attributable to injury or damage that occurred during the

obligated to pay as damages…

policy period.

Courts adopting this approach hold that this language makes all the insurers for multiple years jointly and

Therefore, the policyholder can choose one primary policy to pay all sums and intentionally not touch its primary policies in other years. After the limit of the selected policy has been paid, the policyholder proceeds vertically through its coverage tower for If a company faces long-tail claims such as asbestos,

This is still far more than is needed for a $20 million

that policy period. After all the limits of all the policies

benzene or environmental exposure matters, a key

problem, as long as the $20 million in limits can be

in that period have been paid, the policyholder can

question is how to allocate the costs among the

allocated among those policy years when all that

company’s many years of historical insurance coverage.

coverage was actually available. The policyholder could, for example, move chronologically, exhausting the $1

A carrier with this language will argue that its policy

The company will pay on behalf of the insured

is obligated to pay in damages and defense costs.

For example, consider a scenario in which the corporate

late 1980s, when insuring agreements began to state: We will pay those sums that the insured shall

severally liable for all sums that the policyholder

By Kenneth M. Gorenberg

emphasize a change in policy language beginning in the

The all sums allocation method is based on the insuring typically provided:

LONG-TAIL CLAIMS

Depending on their policy periods, some insurers also

In reality, it’s often impossible to determine the extent of injury or damage that occurred in a particular period.

select another period and move vertically through those policies, and so on. The policyholder can defer or

In reality, it’s often impossible to determine the extent

maybe even disregard entirely the policy periods where

of injury or damage that occurred in a particular period.

it has less coverage available.

For example, when a plaintiff has mesothelioma caused

policyholder received a governmental demand in 2017

million per year for 1971-73 and 1975-77 and $5 million

to perform or pay for a $20 million cleanup of a site that

per year for 1978-79, and use $4 million of the $5 million

the company allegedly contaminated beginning in 1968.

Under this approach, the insured may truly get coverage

for 1981 – while skipping 1974 and 1980. In the event of

Total policy limits were $1 million per year in 1968 through

for all sums it incurs, as long as it has sufficient policy

future claims, the insured would still have $1 million for

1977 ($10 million total for 10 years), then increased to $5

limits among any policy years within the total time period

1981 and $5 million per year for 1982-87, for a total of

at issue. In the hypothetical scenario at the beginning

with an immeasurable amount of injury happening

million per year for 1978 through 1987 ($50 million total),

$31 million available. This important allocation method is

of this article, the policyholder’s existing $20 million

in any particular year. Similarly, in an environmental

generally called “all sums” or “joint and several.”

problem would be fully covered, and it would have $31

matter, there’s usually no way to measure how much

million of coverage available for future claims.

damage occurred in any given year, from the period

$10 million per year for 1988 to 1997 ($100 million), $20 million per year for 1998 to 2007 ($200 million) and $50 million per year for 2008 to 2017 ($500 million).

Does this mean that $860 million in total policy limits is available for a $20 million problem? Unfortunately, no.

If, instead, the $20 million loss must be allocated pro rata across all 50 years from 1968 to 2017, that means $400,000 will be attributed to each year. In particular, the policyholder will have to pay the $400,000 annual

First, in this scenario, the carrier for 1968-70 has long

shares for 1968-70, 1974, 1980 and 1988-2017. That totals

been insolvent. Second, old claims exhausted the limits

$14 million for which the policyholder is uninsured. The

of the 1974 and 1980 policies. Third, all policies since

insurance companies for 1971-73, 1978-79 and 1981-87

1988 have had absolute pollution exclusions. (Sometimes

will pay only $400,000 per year, for a total of only $6

those exclusions are not really absolute, but it is assumed

million for the insured’s $20 million problem. In the event

for the purposes of this article that they do bar coverage.)

of future claims, substantial limits would remain available

So the total limits available are $1 million per year for

on those policies, but the policyholder again would

1971-73 and 1975-77 ($6 million total), plus $5 million per

have to absorb the prorated shares for the other years

year for 1978-79 and 1981-87 ($45 million) for a grand

implicated by those claims. It’s easy to see why insurers

total of $51 million.

generally prefer this pro rata allocation method.

30 | btlaw.com

Pro rata allocation is a legal fiction to limit coverage to injury or damage during the policy period

by asbestos exposure, the disease process typically takes decades to progress from exposure (which likely occurred over the course of many years) to diagnosis,

when releases were happening, through the years when contaminants were migrating, to the point when a governmental agency or private claimant seeks a remedy. The impossibility of determining the extent of

To minimize their liability, insurance companies tend

injury or damage in any given year is compounded when

to focus on policy provisions stating, for example,

the defendant faces multiple asbestos or benzene claims

“[t]his insurance applies only to bodily injury or property

or allegedly caused environmental contamination at

damage which occurs during the policy period.” In

several sites. In seeking to prorate the injury or damage

other words, for a progressive matter like an asbestos

across many policy periods, insurance companies

or environmental claim, the insurance company will

engage in a legal fiction. Simply put, allocating equal

pay only for the injury or damage that occurred in its

amounts to each year conflicts with the reality that the

policy year.

losses for each year were not equal.

2019 Corporate Policyholder | 31

All sums is not unfair to insurance companies

related bodily injury but pro rata for environmental

Yet this idea does not withstand scrutiny. The same

its Viking Pump reasoning and fully embrace all sums

property damage. Courts in Iowa and Massachusetts

insuring agreement language appears in many policies,

based on the insuring agreement, regardless of whether

have applied all sums to defense costs but prorated

with and without anti-stacking, non-cumulation and

a policy has anti-stacking, non-cumulation and prior

Insurance companies also argue that all sums allocation

payments for third-party injury or damage.

prior insurance clauses, and that language should

insurance clauses.

is unfair to them because the policyholder will always pick and choose the policy years providing the most coverage, even if the actual injury or damage in that year was much less. This relies on yet another fiction: that the amount of injury or damage for any given year can be calculated and therefore known to be less than the insurance policy limits available for that year. Indeed, if the amount of loss for a particular year were known, then the policies for that year would pay all sums – the amount for that year – up to the total available limits of the policies for that year.

New York takes some unusual turns New York is often considered a leading pro-insurer jurisdiction and for years seemed to be firmly in the pro rata camp. More recently, however, in In re Viking Pump, Inc., 52 N.E.3d 1144 (NY 2016), the New York Court of Appeals seemingly switched sides by applying the

always have the same meaning. Thus, the better view is that, by inserting anti-stacking, non-cumulation and prior insurance provisions, insurance companies recognized that all sums simply is not susceptible to allocation. Therefore, pro rata allocation should never be ordered in the face of an all sums insuring agreement, even if there is no anti-stacking, non-cumulation and

all sums method. The court did not, however, reverse

prior insurance provision.

itself outright. Rather, it focused on anti-stacking, non-

What next?

cumulation and prior insurance provisions in the policies, which it did not consider in its 2002 Con Ed decision. Id.

Even though Viking Pump has not yielded a complete

Moreover, insurance companies should hardly complain

at 1152-53. In general, these clauses say that when a loss

victory for the all sums allocation method, it was a step

about fairness when they advocate an allocation that

is covered not only by that policy, but also in policies

in the right direction by an insurer-friendly court that

prevents their policyholder from using policies that the

for earlier or later years, the policyholder gets only one

other state courts around the country often look to for

policyholder bought and paid for. That often includes

of those limits and may not stack them up for more

guidance. Having made that step, perhaps the New

policies from decades earlier and for which the insurance

coverage. The Viking Pump court recognized that this

York Court of Appeals in a future case will re-examine

companies collected premiums, invested them and

provision means there must actually be coverage under

never faced prior claims. Insurance companies, which

policies for more than one year, and therefore it applied

are in the business of taking on risk, are trying to shift risk

the all sums doctrine. Id.

back to their policyholders, which generally are in other businesses like manufacturing and construction.

to a policyholder, which will bear its own costs to the

the court’s flawed reliance on the anti-stacking, non-

extent that the per-year allocation exceeds its available

cumulation and prior insurance provisions. For context,

coverage for any given year. In the scenario described

consider that the insurance industry tends to draft and

earlier, insurers would pay only $6 million on the

incorporate a new policy provision as a direct response to

insured’s existing $20 million environmental claim, and

an expanding coverage risk in existing policy language.

future coverage would similarly be limited because

This is what happened when insurance companies began

of the allocation to periods when the company has no

to add anti-stacking, non-cumulation and prior insurance

coverage available.

clauses. The idea, which on the surface may seem to

been adopted by courts across the country with no clear consensus at this point. Some clearly favor all sums.

Others consistently require pro rata allocation. In a third group of jurisdictions, courts have applied both the all sums and pro rata allocations depending on certain

would be open to new arguments. Other states that have favored pro rata allocation in the past may be willing to reconsider. At least equally important, many state Supreme Courts have not firmly decided the issue and may yet hold that all sums should apply broadly in their states. The bottom line for policyholders is not to assume that a pro rata allocation is their only or best option. They may be able to maximize coverage by advocating for an all sums allocation of long-tail claims such as asbestos, benzene or environmental exposure matters.

blanket notion that pro rata allocation should apply in all circumstances, enthusiasm must be tempered by

Both the all sums and pro rata allocation methods have

it is encouraging that a seemingly solid pro rata court

While it is good to see New York depart from the

The result of pro rata allocation is often detrimental

The competition between all sums and pro rata is running neck and neck

Even if New York never completely adopts all sums,

make sense, is that an insurance company should only pay once for a single loss, even if that loss spans more than one policy. The New York court in Viking Pump suggested that anti-stacking, non-cumulation and prior insurance clauses changed the meaning of the insuring agreement to pay all sums.

The bottom line for policyholders is not to assume that a pro rata allocation is their only or best option.

circumstances. For example, Illinois’ Intermediate Appellate Court has applied all sums for asbestos-

32 | btlaw.com

2019 Corporate Policyholder | 33

corporation files a malpractice claim against a corporate

IS EMPLOYED LAWYERS INSURANCE WORTH THE PAPER IT’S PRINTED ON?

counsel, the corporate lawyer will tender the claim back to the corporation for indemnity. By statute in most states, and often by employment agreement, an employer must indemnify an employee who is sued for acts committed in the course and scope of employment.

Assuming the corporation is not in financial trouble, the personal assets of the indemnified corporate lawyer would never be at risk. (An exception would be when the employed lawyer is held to have acted fraudulently, in which case, depending on state law, the corporation’s indemnity obligation may be vitiated.) Why buy insurance for a corporate counsel’s breach of a professional duty of care to his or her employer or fellow employee if the lawyer’s personal assets are protected by the company’s indemnity obligation anyway?

The corporation’s duty to indemnify the in-house lawyer may create an opportunity Employed lawyers insurance policies often include direct in-house lawyer sued by an employee of the corporation.

employee explained that the discrepancy was due to the

reimbursement and corporate reimbursement insuring

The employee was present at a worksite where a

omission of a single word in the second statement, which

agreements. As long as the corporation is indemnifying

coworker slipped and fell due to unsafe conditions.

was written in haste. He was terminated nonetheless.

the in-house lawyer, he or she cannot make a claim

At his employer’s request, the employee gave two

He then sued his employer for wrongful termination and

directly under the policy. Rather, the corporate counsel

Employed lawyers insurance is often sold as an add-

statements about the accident. In the first statement, he

Plummer for legal malpractice, breach of fiduciary duty

must submit a claim for indemnification to the company,

on to directors and officers liability (D&O) policies by

said he did not see the fall and in the second, he stated

and fraud. Plummer prevailed on summary judgment

which then seeks reimbursement from the employed

insurance companies looking to add perceived value to a

he had. In the coworker’s lawsuit against the employer,

by asserting he was not the cause of the employee’s

lawyers carrier in excess of a self-insured retention.

proposal. Typically, no or very little premium is associated

in-house counsel Plummer was assigned to defend the

termination.

with this kind of coverage. Such insurance often covers

employee’s deposition.

By David E. Wood

But if it is the corporation that makes a claim against The California Court of Appeals reversed the trial court,

its employed lawyer, its right to reimbursement from

corporation and other employees of the corporation.

Plummer met with the employee and explained that he

finding that Plummer failed to inform the employee of

the employed lawyers insurer becomes circular. The

While this kind of claim is rare – what company wants

would be his attorney for the deposition. The employee

the lawyer’s potential conflicts and failed to obtain the

company is the plaintiff seeking to redress a loss by

to publicly excoriate its general counsel for mistakes in

expressed concern about his job because he was likely

employee’s written consent to his representation after

asserting the corporate counsel’s liability. The company

doing his or her job? – it does happen, and a corporate

to testify to unsafe conditions at the worksite, so he

disclosure of the conflicts. This was sufficient to create

must indemnify the in-house lawyer for his or her

counsel’s exposure to this kind of liability is more

asked Plummer who would protect him at the deposition.

a triable issue of fact as to whether Plummer’s actions

defense costs and for a settlement or judgment in the

than theoretical. Employed lawyers insurance may be

Plummer responded that as long as the employee told

caused the employee’s firing, and the Court of Appeals

case. If the corporation then seeks reimbursement from

more valuable to the corporate policyholder than the

the truth, his job would not be affected.

allowed the employee’s legal malpractice claim against

the carrier, excess of the retention, for the settlement

the in-house lawyer to proceed to trial.

or judgment, this would in effect turn a third-party

an in-house lawyer’s malpractice exposure to the

underwriter thinks.

Legal malpractice claims against corporate counsel do happen

After the employee testified that he did not see the

liability policy – which covers the insured’s liability to

accident, Plummer showed him the contradictory

This case demonstrates that an in-house lawyer can

the claimant, and does not cover direct losses of the

statements and got him to admit that his deposition

indeed be sued for legal malpractice by the corporation,

policyholder – into a first-party policy that pays the

testimony conflicted with the second statement. He

or an employee of the corporation, for damages that

policyholder in the event of a covered loss.

Consider the California Court of Appeal’s decision in

did not offer the employee a chance to explain the

probably are not insignificant. On the surface this would

Yanez v. Plummer, 2013 Cal. App. LEXIS 891 (Cal. App.,

discrepancy and failed to present the first, consistent

appear to justify the purchase of insurance for in-house

Underwriters of employed lawyers coverage take different

Nov. 5, 2013) reversing summary judgment in favor of an

statement. In the subsequent disciplinary proceeding, the

counsel. But if the corporation or an employee of the

routes to try to avoid this. One carrier writing this kind

34 | btlaw.com

2019 Corporate Policyholder | 35

of insurance uses an “insured vs. insured exclusion” to

While the employer’s own malpractice claim against

eliminate coverage for a claim brought by the corporation

the corporate counsel would still be excluded under

against its in-house counsel (except for defense costs)

this employed lawyers policy form, the coverage seems

unless the claim is for malpractice committed while

designed to fill gaps in D&O coverage. D&O policies

moonlighting, defined as “working for others after hours

sometimes exclude an officer’s liability arising out of

and outside the scope of employment.” Its policy covers

rendering professional services, meaning that a securities

the corporate lawyer’s liability to his or her employer so

fraud claim against the company’s senior vice president

long as the employer has not indemnified the lawyer for

and general counsel arising out of, for example, a mistake

the loss. The policy also states that the corporation is

in registration of an offering of the company’s securities

presumed to have indemnified the corporate lawyer to

would be excluded. In addition, many D&O policies

the fullest extent permitted by law. Under this product, if

would exclude a claim against an employed lawyer who

the corporate employer sues the employed attorney for

is not an officer of the company. If a general counsel or

malpractice and does not indemnify him or her, the carrier

junior employed lawyer is sued for securities fraud in a

will pay the lawyer’s defense costs, but not a settlement of

shareholder class action based on a registration error,

the employer’s claim or a judgment in its favor against the

and the action also names the employer and its directors

employed lawyer.

and officers, this employed lawyers policy would bring an

INTERVIEW WITH BROOKE TASSONI

Senior Lawyer, Litigation Practice Team Lead, Cargill Inc. For over 150 years, Cargill has been helping farmers prosper, connecting markets and advancing the food and agricultural business to sustainably nourish the world. Today it’s the world’s largest privately held company, with customers in 70 countries and regions and 155,000 employees. And because Cargill touches every part of the global food chain, the company’s legal department contends with a vast range of issues and risks every day, from bio-industrial issues to animal nutrition to workplace safety.

Brooke Tassoni is a senior lawyer and litigation practice team lead at Cargill. She received her J.D. from the University of Minnesota Law School after graduating from Carleton College. After five years at Robins, Kaplan, Miller & Ciresi in Minneapolis, she started working at Cargill in 2006. She leads the company’s six-person United States litigation team and is the lead lawyer for their global insurance group.

She agreed to an interview with Corporate Policyholder to talk about how lawyers work at Cargill.

additional payment source to the table to help settle the Why would a company buy such a policy? As long as

case. Employed lawyers policies like this one appear to

the employed lawyer is not moonlighting, his or her only

have value.

client is the corporation that would pay the premium. The corporation alone would decide whether to sue the in-

It is worth noting that employed lawyers policies that cover

house counsel for malpractice. Knowing the policy would

moonlighting may be more valuable than they appear.

not cover the employed lawyer’s liability for mistakes

The corporate employer has no incentive to buy insurance

made within the scope of employment, the employer

for an in-house lawyer who represents other clients on

presumably would see little value in buying insurance

the side without authority, but it very well might want to

for the very thing it conceivably could need to protect its

cover the employed attorney for malpractice liability while

assets in the event the corporation counsel makes such a

serving on the board of a nonprofit or doing pro bono work.

mistake. The employer also may see no benefit to buying

Many companies encourage their employed lawyers to do

malpractice coverage for the lawyer who runs a law

these kinds of community service because these activities

practice on the side (i.e., moonlighting) since this could be

benefit the company’s reputation. Insuring against

seen as tacitly encouraging unauthorized after-hours work

malpractice claims arising from these services gives the

for other clients. This carrier’s policy would not seem to be worth very much unless there is some specific reason to

CP: Can you talk a little bit about your role at Cargill

CP: What’s one responsibility or issue that you put

and what falls under your purview?

energy into each working day and why?

Brooke Tassoni: I lead our litigation team in the U.S. and

BT: My focus each day is managing risk in a way that’s

support our global insurance function. The legal issues

both cost-effective and pragmatic for my clients. That

Cargill faces are very diverse, and our litigation portfolio is

effort bleeds into all our work, whether it be litigation,

diverse as a result. Our team deals with multiple areas of

contracts, regulatory, or general advice and counsel.

law on any given day.

CP: Who manages the defense of a lawsuit that’s CP: What are the most significant legal issues

covered by insurance?

confronting Cargill today?

BT: Because of our unique insurance structure, we

employer a way to defray the cost of protecting the lawyer

BT: As business becomes more global, our issues become

typically manage our own matters and choose our own

and its reputation in the public eye.

more complex. At Cargill, we’re focused on maintaining

counsel, cooperating with our carriers at various levels,

excellence in our core business areas – ensuring that

when necessary. For the most part, coverage is not

Many D&O underwriters use employed lawyers

products we produce to nourish the world are safe and

typically established until after a matter is over, so we run

insurance as an add-on to sweeten a deal and beat the

that we’re operating in a responsible, ethical manner. Like

some coverage risks with that kind of structure. We’re

“insured vs. insured exclusion” eliminating coverage for

competition, charging a nominal premium or no premium

other global businesses, however, we face increasingly

fortunate to have carriers with whom we have had long,

a corporate counsel’s liability to the corporation, but not

at all for the coverage. The relative value of this insurance

complex issues in managing cross-border relationships,

successful relationships, and we’re typically able to solve

the lawyer’s otherwise-covered liability to shareholders

is driven by policy wording. There are no standard forms

global compliance, data privacy and cybersecurity, and

issues without resorting to litigation. On occasion, however,

acting independently of the company or liability to

for this kind of coverage, and as the two examples above

artificial intelligence.

we do find ourselves in a dispute, particularly when legacy

another employee for mistakes in legal services provided

illustrate, the relative value of policies on the market can

by the employed lawyer. The corporate employer may

vary widely. If the right form of insurance is offered, it can

CP: What are your own principal concerns and those of

have good reason to buy this policy because it would

provide a lot more value to the corporate insured than a

Cargill’s legal department?

CP: Talk about the client-law firm relationship, how it’s

cover the employer for amounts it pays to indemnify

low- or no-premium commitment would suggest.

BT: Safety is a huge priority both in terms of the products

evolving and what Cargill looks for in its outside legal

the employed lawyer in shareholder litigation and for

we produce and our environment and business operations.

counsel.

malpractice liability to other employees.

It’s a key concern, if not the key concern, for our business

BT: What we seek is value – the optimum balance

professionals and our lawyers.

between cost and results. For some companies, the

have moonlighting coverage (more on this below).

Another carrier’s employed lawyers policy includes an

36 | btlaw.com

policies are in play.

2019 Corporate Policyholder | 37

focus may be more on cost certainty or cost reduction.

procurement efforts. They sponsor education, policies and

Given our diverse portfolio and our matter composition,

procedures that help us build more diverse workplaces at

we’re focused on finding firms and lawyers who deliver

Cargill and in the larger community. We also participate in

a high-level, strategic performance at the right cost. We

diverse lawyer resource groups like Diversity in Practice,

value partners who really understand our business, our

among others.

culture and our goals. We have some unique needs, so it’s important that our services are tailored and right-sized. We

CP: How can in-house counsel help minority lawyers

also need lawyers who can push a matter forward, which

advance within the legal industry?

Barnes & Thornburg has done well.

BT: In-house counsel can have a significant impact on diversity in the legal profession. First, corporations can

CP: What does a diversified workplace mean to

align to retain firms who are consistently meeting diversity

Cargill?

goals and who’ve demonstrated success with hiring

BT: We aim to have a workplace that is welcoming of

and retaining diverse professionals. Second, in-house

people from all walks of life. Being a global company,

counsel can invest in diverse lawyers in the community by

Cargill actively recognizes that a diverse workplace

participating in the aforementioned resource groups, by

makes good business sense by improving outcomes and

mentoring diverse associates, and by seeking out diverse

workstreams. Diversity is becoming part of Cargill’s culture

talent at all levels of practice. In-house counsel can also

– more and more each day.

impact change at a matter level by insisting that diverse lawyers, both partners and associates, perform a certain

CP: How does Cargill approach diversity to ensure that it’s implemented at all levels?

BT: We have a global team and regional subgroups that address D&I in our own environment, as well as our

38 | btlaw.com

percentage of work on individual matters.

11 South Meridian Street Indianapolis, Indiana 46204-3535

AT THE HEART OF POLICYHOLDER PROTECTION Uncommon value for clients who shape our everyday lives.

ATLANTA CALIFORNIA CHICAGO DELAWARE INDIANA MICHIGAN MINNEAPOLIS OHIO TEXAS WASHINGTON, D.C.

btlaw.com

Explore the BT Policyholder Protection blog at www.btlaw.com/insights/blog