Corporate Policyholder Magazine | Fall 2019

POLICYHOLDER

Volume 3

CORPORATE Risk. Recover. Repeat.

IN THIS ISSUE: MAINTAINING VIGILANCE: A CARRIER’S ACCEPTANCE OF ITS COVERAGE OBLIGATIONS IS ONLY THE BEGINNING

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BUILDING AN INSURANCE BAD FAITH CASE

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A RANSOMWARE ATTACK COULD DEVASTATE YOUR COMPANY

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LETTER FROM THE PUBLISHER Dear Readers, It has never been more important for businesses,

policy – which helps explain the value of forging insurer

particularly large companies, to have strong

partnerships throughout a tower that remain strong

relationships with their insurance carriers.

when a catastrophic claim occurs.

That is what we hear in the world of insurance as we

As Laurence Midler, general counsel of CBRE, said in

near the end of the second decade of the 21st century,

the feature Q&A published in this issue, “The worst-

and it is one of the major themes of our newest issue

case scenario is we call them and tell them we want

of Corporate Policyholder magazine, a publication

to settle a case, and the insurers reply that they don’t

of the Barnes & Thornburg Insurance Recovery and

have enough information to evaluate the exposure

Counseling Practice Group.

because we haven’t kept them apprised as the case has

This issue comes as companies around the world face liability challenges that have been accelerating in recent years. Say you are a large software developer

unfolded. This can lead to high-pressure negotiations just when we need our carriers most. It’s why we take pains to keep relationships as strong as possible.”

that maintains huge global platforms. You have

This isn’t easy. Insurance companies aren’t always

almost unlimited liability exposure if something goes

cooperative when the chips are down. It just goes to

wrong – from cyber incidents like ransomware attacks

show how difficult maintaining carrier relationships can

to software failures, and many more. The ever-

be for policyholders, adding to the list of complex issues

increasing sophistication of cyberattackers and the

they must confront day in and day out as they shelter

sheer complexity of systems make for a risk-intensive

their businesses from risk.

environment in which strategic placement of insurance programs has never been more important.

We hope the articles in this issue provide corporate policyholders with valuable knowledge that will help

Because there is only so much capacity among insurers,

them take on these challenges in the complicated

large corporations must buy towers of policies to meet

process of shifting risk off their balance sheets and onto

the loss and liability challenges inherent in their fields.

those of their insurers.

Excess carriers, particularly the ones highest in a tower, are not always in it for the long haul, and big companies work constantly to keep them in the game. The scope of coverage the excess insurers follow is often defined almost entirely by the underwriter of the primary

Insurance Recovery and Counseling Practice Group Barnes & Thornburg LLP Fall 2019

“The worst-case scenario is we call them and tell them we want to settle a case, and the insurers reply that they don’t have enough information to evaluate the exposure . . .” – CBRE General Counsel Laurence Midler For up-to-the minute insights about insurance recovery, read the Policyholder Protection blog at www.btlaw.com/en/insights/blog.

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TABLE OF CONTENTS

Page 4

Bodily Injury Exclusions In E&O Policies

Page 8

An Appraisal Of The Appraisal Remedy In Property Insurance

Page 12

A Carrier’s Acceptance Of Its Coverage Obligations Is Only The Beginning

Page 19 Page 23

Not the Weapon Underwriters May Think They Are

Maintaining Vigilance

Coverage May Exist For Companies Facing Allegations Related To Sexual Abuse Building An Insurance Bad Faith Case

Obtaining Discovery Of The Insurer’s Subjective State Of Mind Through Loss Reserves, Reinsurance Communications And Similar Claims

Page 28

Interview With Laurence Midler

Page 30

A Ransomware Attack Could Devastate Your Company

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CBRE General Counsel

Will Your Insurance Cover It?

Case Summaries

Staying Up To Date On Insurance Policy Law Is Critical. Here Are A Few Significant Insurance Cases Decided Recently.

The articles in this publication should not be construed as legal advice or legal opinions concerning any specific facts or circumstances. The contents are intended for general informational purposes only. Please consult your coverage counsel about specific legal questions raised by these articles.

Fall 2019 Corporate Policyholder | 3

BODILY INJURY EXCLUSIONS IN E&O POLICIES:

NOT THE WEAPON UNDERWRITERS MAY THINK THEY ARE

By: David E. Wood and Robert G. Devetski Professional services companies, such as a real estate brokerage, a securities broker-dealer or a technology services company, look to their professional liability insurance, often referred to as an errors and omissions (E&O) policy, for coverage when they are sued for mistakes in serving their customers. While E&O policies cover business litigation risks arising from claims for economic losses – such as a bank’s liability to a customer for allowing a wrongdoer access to its accounts – damages resulting from professional errors can expand beyond the purely economic. This can result in a disconnect between the insured’s expectations of coverage and what the underwriter thinks are the policy’s limitations.

E&O policies routinely include an exclusion for “bodily injury” on the theory that coverage for property damage (things getting broken) and bodily injury (people getting hurt) is confined to Commercial General Liability (CGL) policies. But a CGL policy issued to a service provider typically contains a professional services exclusion stating that coverage is eliminated for claims arising from the rendering or failure to render professional services to others for a fee. This kind of exclusion is meant to distinguish E&O from CGL policies, on the assumption that a service provider’s liability for bodily injury can never arise from mistakes in providing services. Insurance company orthodoxy holds that CGL policies alone cover

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damages for bodily injury, E&O policies cover economic damages but not damages for bodily injury, and never the twain shall meet.

Some EPLI underwriters sell cut-rate policies containing this broad exclusion, aware that it leaves uncovered a significant portion of the very liability the policy is intended to address. Many others write policies that exclude

Yet this supposed article of faith does not stand up to scrutiny. Service providers face the risk of liability for bodily injury to others arising out of the business of rendering services in many situations where economic and bodily injury damages overlap, and where covering one but not the other defeats the fundamental purpose of the policies such companies purchase. An example is employment practices liability insurance (EPLI), which covers an employer’s liability to employees for discrimination, wrongful termination, harassment and retaliation. These kinds of liability often lead to economic damages, such as lost wages measured by the difference between what a wrongfully terminated employee earned while working for the employer and the lesser amount he or she was able to earn after being fired. But the employee may also suffer emotional distress from being mistreated, and a broad exclusion for injury to the person would defeat the purpose of the policy by wiping out a large, foreseeable portion of the recoverable damages.

Not having coverage for an employee’s emotional distress would make EPLI policies less valuable and more difficult to sell.

bodily injury, mental anguish and emotional distress, but add an exception to the exclusion for “that portion of a Claim seeking damages for emotional distress or mental anguish when resulting from a Wrongful Act of an Insured.”

This exception is the underwriter’s way of excluding an employee claim that is exclusively for emotional distress, untethered to economic damages typical to claims alleging the wrongful termination from or interference with employment. This carve-back restores the basic value proposition of the policy: to cover an employer’s liability to an employee for employment-related wrongful acts no matter how the damages flowing from the wrongful act are manifested.

Smart professional liability underwriters use the same device to avoid gutting E&O coverage where a claimant alleges both economic and bodily injuries caused by negligence in rendering or failing to render services. They sell policies that exclude bodily injury and emotional distress subject to a similar exception aimed at reinstating coverage where bodily injury flows directly from the foundational risk being insured. A typical exclusion eliminates coverage “unless arising directly out of any act, error or omission on the part of the Insured

This carve-back restores the basic value proposition of the policy: to cover an employer’s liability to an employee for employment-related wrongful acts no matter how the damages flowing from the wrongful act are manifested.

in rendering or failing to render professional services.”

Coverage is retained where noneconomic damages are the direct result of the fundamental scope of the risk driving sale of the policy: coverage for liability arising from professional mistakes.

Yet, even in the absence of this kind of carve-back, some courts recognize that a bodily injury exclusion in an E&O policy can defeat the basic purpose of insurance for professional services errors, seriously undermining its value. In Search EDP, Inc. v. American Home Assur. Co., 267 N.J. Super. 537 (1993), an employment agency insured under a CGL policy and an E&O policy had hired an employee without performing an adequate background check. When that employee committed a violent assault against a coworker, the victim sued, asserting that her injuries were directly attributable to the agency’s professional negligence. E&O insurer American Home contended there was no coverage based on the bodily injury exclusion.

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Rejecting this argument, the court concluded that the agency – whose chief business activity was to vet employees for hiring by its clients – had been professionally negligent in failing to perform a background check and that this negligence was the proximate cause of the victim’s injuries. The court recognized that the purpose of the E&O policy sold

by American Home was to protect the agency from its professional negligence in failing to adequately investigate the background of people it referred to its clients. It held that: As Justice Jacobs instructed in Kievit v. Loyal Protect.

Life Ins. Co., 34 N.J. 475, 483 (1961), “[w]here particular provisions, if read literally, would largely nullify the insurance, they will be severely restricted so as to enable fair fulfillment of the stated policy objective.”

This principle applies here. The purpose of the errors and omissions policy is to protect an insured who

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commits an act of professional negligence. If an act of professional negligence causes actionable damage to another, but if the insured’s right to protection depends not on the nature of the act but rather on the nature of the resulting damage, we believe that the stated policy objective would be substantially nullified. We thus conclude that the errors and omissions policy here will fairly fulfill its stated objective only by reading the bodily injury exclusion as excepting bodily injury claims alleged to have resulted from an act of professional wrongdoing.

Search EDP, Inc. v. Am. Home Assur. Co., supra, 267 N.J. Super. at 545.

The court’s rationale for this ruling lay in the proximate cause doctrine, which holds that “[w]here a peril specifically insured against sets other causes in motion

which, in an unbroken sequence and connection between the act and final loss, produces the result for which recovery is sought, the insured peril is regarded as the proximate cause of the entire loss.” Other courts have articulated this doctrine in terms of concurrent causation, holding that where the insured’s liability for an indivisible injury is proximately and directly caused by a covered act or event, the insurer must pay the entire loss – even if non-covered events also contributed to it.

See Mailhiot v. Nationwide Mut. Fire Ins. Co., 169 Vt. 498, 500 (1999); Centermark Properties, Inc. v. Home Indem. Co., 897 S.W.2d 98, 102 (Mo.App.1995); Allstate Ins. Co. v. Watts, 811 S.W.2d 883, 887 (Tenn.1991); State Farm Mut. Auto Ins. Co. v. Partridge, 10 Cal.3d 94, 101 (1973). This rule is upheld with greater vigor where the covered conduct causes the very liability the policy is designed to cover. See Lawver v.

Boling, 71 Wis.2d 408, 422-23 (1976); Waseca Mut. Ins. Co. v. Noska, 331 N.W.2d 917, 923 (Minn. 1983).

The Search EDP opinion, though issued in 1993, remains good law in New Jersey, and has been cited favorably by other courts. See Watkins Glen Cent. Sch. Dist. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA., 732 N.Y.S.2d 70, 74 (2001); RLI Ins. Co. v. Hartford Cas. Ins. Co., No. CV 3:083497-JRM, 2011 WL 13238691, at *5 (D.S.C. 2011); Bd. of Pub. Educ. of Sch. Dist. of Pittsburgh v. Nat’l Union Fire Ins. Co. of Pittsburgh, 709 A.2d 910, 917 (Pa. Super. Ct. 1998). The rationale of the decision upholds the premise underlying many professional liability underwriters’ use of the carve-back in the bodily injury exclusion for claims “arising directly out of any act, error or omission on the part of the Insured in rendering or failing to render professional services.” With or without this carve-back, the inherent value of professional liability insurance can only be fully realized by applying the reasoning of the court in Search EDP. Sophisticated professional services providers want broad coverage for services-related mistakes. They feel frustrated and mistreated when they are denied coverage for the very liability the policy was conceived to cover, solely because the result of the covered liability – bodily injury occurring far down the chain of causation – is deemed excluded. Decisions like Search EDP bolster their reasonable expectation that a professional liability underwriter’s withholding of coverage under these circumstances is unfair and incorrect.

David E. Wood is a partner in Barnes & Thornburg’s Los Angeles office. 310-284-3793 or david.wood@btlaw.com Robert G. Devetski is a partner in Barnes & Thornburg’s South Bend, Indiana, office. 547-237-1147 or robert.devetski@btlaw.com

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AN APPRAISAL OF THE APPRAISAL REMEDY IN PROPERTY INSURANCE

By Charles P. Edwards While the appraisal remedy can be an efficient and effective way to settle valuation disputes arising from a loss under a property policy, the decision whether to invoke or to resist it involves many legal and strategic nuances. When coverage issues are being disputed, insurers often demand an appraisal to avoid a court or jury ruling on the policyholder’s damages, while also attempting to exclude or limit coverage. This can result in a longer and more expensive claim resolution process than litigation. Policyholders should therefore give careful consideration to the appraisal remedy and its consequences.

The Appraisal Clause The appraisal remedy is a feature of most property insurance and builders risk insurance policies. Some states go so far as to require the remedy. An appraisal clause reads something like the following: If you and we do not agree on the amount of loss or damage, either party may make a written demand for an appraisal of the loss or damage. …

Each appraiser will separately state the value of the property and the amount of the loss or damage. If the appraisers do not agree, they will submit their statements to the umpire. Agreement by the umpire and either of the appraisers will be binding on you and us.

Some policies include time periods for demanding an appraisal and procedures for selecting the appraisers and/or the umpire. The policy also may require that the appraisers and/or umpire be “competent,” “disinterested” or “impartial.”

The appraisal language may appear simple, but it leaves many questions unanswered. What does “the amount of loss or damage” mean? Who decides? How are the appraisers selected? What, if any, qualifications are there for the appraisers and the umpire? What are the rules for the appraisal? Are there any post-appraisal remedies from an adverse appraisal ruling? Can a party waive the right to an appraisal?

There are few reported court decisions answering these questions, due in part to the fact that the remedy is extrajudicial and therefore keeps insurer conduct out of the public eye. But that isn’t always the case; some appraisals

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can be as lengthy and expensive as litigation, and they can complicate the resolution of insurance claims.

The Scope of Appraisal: ‘The Amount of Loss or Damage’ Nearly all appraisal clauses apply to disputes over “the amount of loss or damage.” Courts have universally agreed that this language means appraisals may not resolve disputes over the coverage provided by the policy.

As stated in 15 COUCH ON INSURANCE § 212:13 (3d ed.

2019), “Questions concerning policy defenses or coverages are not to be addressed by the appraisers.” But courts and appraisers have not necessarily agreed on where the line is between coverage and the amount of loss or damage.

In High Country Arts and Craft Guild v. Hartford Fire.

Ins. Co., 126 F.3d 629 (4th Cir. 1997), for example, the appraisers issued an appraisal of the policyholder’s business interruption claim capped at 60 days of lost revenue based on their conclusion that the insurance policy provided for only 60 days of business interruption coverage. The policyholder sued, seeking the 12 months of coverage it contended was available under the policy.

The jury returned a verdict in the policyholder’s favor, which the U.S. Court of Appeals for the Fourth Circuit affirmed, rejecting the insurance company’s argument that the parties were bound by the appraisers’ 60-day award.

The court held that the appraisers had misinterpreted the policy and that the parties were not bound by the appraisers’ interpretation of what coverage was afforded by the policy.

Separating coverage disputes from disputes over the amount of loss or damage is sometimes easier said than done. This can result in complex proceedings that need to be carefully and strategically orchestrated. See, e.g., SR Int’l Business Ins. Co., Ltd. v. World Trade Ctr. Props., LLC, 445 F. Supp. 2d 320 (S.D.N.Y. 2006) (deciding legal issue of what is included in replacement cost in the context of an ongoing appraisal, noting that “[t]his court has jurisdiction to resolve the parties’ present dispute despite the ongoing appraisal proceeding because the Appraisal Panel may not decide questions of law”); SR Int’l Business Ins. Co., Ltd. v. World Trade Ctr. Props., LLC, 2007 WL 519245 (S.D.N.Y. Feb. 16, 2007) (instructing appraisal panel on legal issues affecting claim for rental value loss); SR Int’l Business Ins. Co., Ltd. v. World Trade Ctr. Props., LLC, 375 F. Supp. 2d 238 (S.D.N.Y. 2005) (same); Duane Reade, Inc. v. St. Paul Fire & Marine Ins. Co., 411 F.3d 384, 389 (2d Cir. 2005) (“[N] o appraisal can occur until the legal parameters for valuating...losses have been set.”)

A frequent dispute in first-party property insurance claims involves whether the damage was caused by a covered cause of loss or by some other cause, and whether a court or appraisal panel should decide this question. Courts have differed on whether causation questions are to be decided by courts or appraisers. In State Farm Lloyds v.

Johnson, 290 S.W.3d 886 (Tex. 2009), for example, the Supreme Court of Texas held that “when an indivisible injury to property may have several causes, appraisers can assess the amount of damage and leave causation up to the courts,” and “[w]hen divisible losses are involved, appraisers can decide the cost to repair each without deciding who must pay for it.” Id. at 894.

Also, in Johnson v. Nationwide Mut. Ins. Co., 828 So. 2d 1021, 1022 (Fla. 2002), the Florida Supreme Court held that “[causation is a coverage question for the court when an insurer wholly denies that there is a covered loss and an amount-of-loss question for the appraisal panel when an insurer admits that there is covered loss, the amount of which is disputed.” In Rogers v. State Farm Fire & Cas. Co., 984 So. 2d 382, 392 (Ala. 2007), the Alabama Supreme Court held that “[t]he determination of the causation of these matters is within the exclusive purview of the courts, not the appraisers.” In Walnut Creek Townhome Ass’n v.

Depositors Ins. Co., 913 N.W.2d 80, 92 (Iowa 2018), the Supreme Court of Iowa held that causation is a question for the appraisers when determining the amount of loss from an insured event.

Another frequently disputed issue in first-party property claims involves the appropriate scope and cost of repair.

While at first blush this might appear to be a dispute over the amount of loss or damage, it frequently involves questions regarding what is covered by the policy. For example, the policy may say that it covers repair or replacement with materials of “like kind and quality” but not provide any definition of these terms, or the policy may say that it provides “replacement cost” coverage, without defining what that means. Some guidance is found in Volume 2 Insurance Claims and Disputes 6th § 9:33 (March 2008), which concludes, “In general, an appraisal resolves solely the amount of a loss. It generally does not, for example, resolve the issue of what constitutes ‘like kind and quality.’ And, in general, it does not resolve coverage issues.”

The bottom line is that debates often arise about what constitutes an appraisable dispute over the “amount of loss or damage” and what constitutes a non-appraisable “coverage” dispute. In any given claim, this debate may need to be resolved by a court.

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UNLIKE REAL ESTATE APPRAISERS, APPRAISERS OF PROPERTY INSURANCE LOSSES ARE NOT GOVERNED BY ANY INDUSTRY STANDARDS OF CARE.

The Appraisal Rules The first rule of appraisal is that there are no rules.

Policies generally allow each party to name its own appraiser and often say a court may select an umpire if the parties or their appraisers cannot agree on one. But rarely does the policy language address qualifications for the appraisers or the umpire, or specify procedures for the appraisal. Parties either need to work together or involve a court in setting the rules for an appraisal, which can differ from case to case depending on the nature of the damage and the existence of any coverage disputes.

Typically, parties choose appraisers who are industry experts in the particular area involved in the dispute. For simple disputes involving a single type of damage – say, the scope of hail damage to a roof – the appraiser’s expertise may be evident and may be able to cover the full scope of the dispute. Large, complex insurance claims, however, often involve many different types of expertise. In those cases, a party may name a consulting firm or general contractor as its appraiser, who may then rely on the opinions of various subcontractors, 10 | btlaw.com

vendors or other subspecialists to complete the appraisal opinion. The parties also can agree to conduct separate appraisals for different types of loss or damage.

Unlike real estate appraisers, appraisers of property insurance losses are not governed by any industry standards of care. As noted above, the policy language at most may say that the appraisers and/or umpire must be “competent,” “disinterested” or “impartial.” This language has been called into action most often when a party’s appraiser has a potential financial benefit based on the outcome of the appraisal.

The Colorado Supreme Court recently addressed this issue in the context of policy language that said “each party will select a competent and impartial appraiser” in Owners Ins. Co. v. Dakota Station II Condo. Ass’n, Inc., 443 P.3d 47 (Colo. 2019). The insurer alleged that the policyholder’s appraiser was not impartial because she had agreed with the agent for one of the parties to cap her fees at 5 percent of the insurance award (allegedly giving her a financial interest in the outcome). The court first held, “Based on the plain meaning of the word

impartial, we conclude that the policy requires appraisers to be unbiased, disinterested, and unswayed by personal interest. They must not favor one side more than another.

This means no advocacy on behalf of either party.”

Because the award did not reach the stated cap and the parties did not believe the cap was in effect, the court held that the cap did not come into play and therefore did not demonstrate bias.

Courts differ on where to draw the line on the independence of appraisers. In Rios v. Tri-State Ins. Co., 714 So. 2d 547 (Fla. Dist. Ct. App. 1998), the Florida Court of Appeals held that an appraiser paid whose fees were measured by a percentage of the award was an “independent appraiser” within meaning of the appraisal clause requiring insured and insurer to select an “independent appraiser.” Other courts have disagreed, holding that incentives like contingency fees give appraisers a financial interest in the dispute, which constitutes grounds for voiding the appraiser’s assessment. See Cent. Life Ins. Co. v. Aetna Cas. & Sur. Co., 466 N.W.2d 257, 261 (Iowa 1991).

Waiving the Right to Appraisal Most courts hold that the right to demand an appraisal may be waived. Waiver may occur for example when the party seeking an appraisal actively participates in a lawsuit or engages in conduct inconsistent with the right to appraisal. Unreasonable delay in seeking an appraisal also may waive the right, although some courts may require prejudice to the nondemanding party. The insurer’s denial of coverage for the property loss also may waive its right to an appraisal.

But they rarely define what is meant by “binding.” Most courts hold that a party may not challenge a properly rendered appraisal decision, using different tests for whether the appraisal was proper. Texas courts will disregard an appraisal when 1) the award was made without authority; 2) the award was made as a result of fraud, accident or mistake; or 3) the award was not in compliance with the requirements of the policy. Under Indiana law, an appraisal is binding unless it can be shown that the appraisal is infected with unfairness or injustice.

It also may be possible to challenge an appraisal before it takes place. If the appraisal is conducted by court order over the objection of one party, that order may be appealable. Florida’s Rules of Appellate Procedure, for example, provides for an immediate appeal of a ruling determining the entitlement of a party to an appraisal under an insurance policy.

Authorities and industry practice demonstrate that when a valuation dispute arises under a property insurance policy, the appraisal remedy can be far less simple than it seems.

In some cases, litigation may be necessary over details of the appraisal and/or coverage issues, which can defeat the appraisal remedy’s purpose of creating an expedited alternative to a judicial decision on valuation. But with some valuation disputes, appraisal can be an efficient and effective procedure for resolving valuation disputes.

Policyholders should give careful consideration to when and how to invoke and structure the appraisal remedy.

The Binding Nature of an Appraisal Most appraisal clauses conclude by saying that “agreement by the umpire and either of the appraisers will be binding on you and us,” or language to this effect.

Charles P. Edwards is a partner in Barnes & Thornburg’s Indianapolis office. 317-231-7438 or charles.edwards@btlaw.com

Under Indiana law, an appraisal is binding unless it can be shown that the appraisal is infected with unfairness or injustice.

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MAINTAINING VIGILANCE:

A CARRIER’S ACCEPTANCE OF ITS COVERAGE OBLIGATIONS IS ONLY THE BEGINNING

By John P. Fischer

You tendered a lawsuit to your liability carrier. You cooperated with its investigation of the claim, and maybe you had to challenge an initial denial. Now, you have a hard-earned letter from your carrier agreeing to defend the suit. This is a significant milestone in managing your risk arising from the liability, but the need for vigilance to maximize your insurance benefits and protect your rights is far from over. Whether there are thousands or millions of dollars at stake, policyholders must remain vigilant and active to ensure they are receiving maximum benefit from their coverage.

A multitude of disputes may still arise that can affect whether you maintain control over the defense and settlement strategy and decisions, and whether the carrier pays the full amount of defense costs and a settlement of the lawsuit.

Here are nine of the most frequent issues that arise after a carrier has acknowledged its duty to defend, all of which require the prompt attention of your risk manager, general counsel or outside coverage counsel.

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1. CHOICE OF COUNSEL. Most primary liability policies give the carrier both the duty and the right to defend a lawsuit against the policyholder. This right to defend implicitly, and sometimes explicitly, includes the right to select defense counsel to defend the policyholder. A carrier’s selection of counsel can be problematic for policyholders in many ways. Maybe the carrier chooses a lawyer who charges a very low hourly rate but has little experience in the area of law at issue in the suit. Maybe there is a risk that the lawyer is more loyal to the carrier than the policyholder. For

In this situation, the policyholder will be justifiably concerned that either the carrier or the carrier’s chosen defense counsel, intentionally or unintentionally, may steer the defense away from coverage so that, if the policyholder is ultimately found liable, the liability is excluded, rather than covered, conduct. In instances where the carrier has appointed panel counsel who relies on insurers to keep their doors open, the concern becomes even greater.

Once such a conflict arises, in many states policyholders have the right to

example, the lawyer may serve as the

independent counsel (paid for by the

carrier’s go-to “panel” counsel for other,

insurer and selected by the policyholder

unrelated matters – with most, or all, of his

or the policyholder and the insurer)

or her invoices being paid by the carrier. Or

with an independent duty of loyalty to

maybe the carrier reserves its rights to later

the policyholder. Policyholders must

deny coverage, likely giving rise to a conflict

affirmatively assert this right and request

of interest between the carrier and the

independent counsel. For example, the

policyholder.

Minnesota Court of Appeals has recognized the concern that “counsel selected by the

A simple example is a toxic tort suit where

insurer will have a compelling interest in

the plaintiff asserts a variety of claims

protecting the rights of the insurer rather

against the policyholder, ranging from

than the rights of the insured because

strict liability to negligence to intentional

of counsel’s closer ties with the insurer.”1

conduct. The liability policy covers the

Under Indiana law, conflicts giving the

strict liability and negligence claims but

policyholder the right to choose counsel

not the claim for intentional conduct. If the

at the carrier’s expense arise where “(1)

policyholder is ultimately held liable, it is in

the insurer may steer the defense so as to

the policyholder’s interest to be liable for

make the likelihood of a plaintiff’s verdict

negligent conduct or strict liability because

greater under an uninsured theory; [and] (2)

those claims are covered by the policy. The

the insurer may offer a less than vigorous

carrier, however, has an incentive to steer the

defense if the insurer knows that it can later

liability toward intentional conduct because

assert non-coverage....”2

that liability is excluded under the policy.

Mutual Service Cas. Ins. Co. v. Luetmer, 474 N.W.2d 365, 368 (Minn. Ct. App. 1991); see also Grain Dealers Mut. Ins. Co. v.

Cady, 318 N.W.2d 247, 251 (Minn. 1982) (carrier’s reservation of rights on an issue to be determined in the underlying suit creates a conflict, entitling the policyholder to select defense counsel at carrier’s expense).

2 Armstrong Cleaners, Inc. v. Erie Ins. Exch., 364 F. Supp. 2d 797, 814 (S.D. Ind. 2005).

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California has even codified these principles: “[W]hen an insurer reserves its rights on a given issue and the outcome of that coverage issue can be controlled by counsel first retained by the insurer for the defense of the claim, a conflict of interest may exist.”3 Some states, like California, impose a duty to provide independent counsel where the insurer’s reservation rights creates a qualifying

Carriers must stay within the bounds of good faith, giving adequate regard to the policyholders’ interests.

conflict, meaning one presenting the opportunity for the carrier’s chosen defense counsel to deflect the lawsuit’s outcome away from coverage. Other states impose this duty whenever the insurer issues any reservation of rights. Still others require the insurer to pay for independent counsel not to protect the policyholder’s right to coverage under insurance law, but to protect the insured’s right to be defended by an unconflicted lawyer on professional liability grounds.

Knowing when and how to identify these conflict situations, and to exercise the right to select counsel at your carrier’s expense, will make a significant difference in the quality of your defense and the confidence you have in it.

2. “REASONABLE AND NECESSARY” DEFENSE COSTS. Even when the policyholder with a duty to defend policy gains the right to choose independent counsel at the carrier’s expense, the carrier may try to control rates and foist part of the costs onto the policyholder by claiming that independent counsel’s rates are too high or that important defense activities (such as attorney conferences to strategize and to avoid duplication of effort, or multiple attorney participation in critical case events) are not “reasonable and necessary.” Many jurisdictions have rejected these attempts and provided policyholders with tools to fight back.

For example, Illinois law recognizes that “[a]ttorneys must meet to discuss case strategy and other issues in the litigation. In fact, failure to meet would likely result in duplicative or non-essential work performed due to the lack of strategy or master plan.”4 And Missouri law recognizes that “[h]aving several attorneys attend the same meeting or participate in the same conference call promotes the exchange of different perspectives on a particular legal strategy....”5 Policyholders must adequately protect their rights on these issues, or they could end up facing a big chunk of the defense bill despite the carrier’s agreement to provide independent counsel.

Cal. Civ. Code Ann. §2860(b).

Emmenegger v. Bull Moose Tube Co., 33 F. Supp. 2d 1127, 1139 (E.D. Mo. 1998).

5 Stamm v. Provident Life & Accid. Ins. Co., 2000 U.S. Dist. LEXIS 5521, at *5 (N.D. Ill. Apr. 7, 2000).

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3. CONTROL OF DEFENSE AND SETTLEMENT. Liability policies with a duty to defend typically give the carrier the right to control defense and settlement decisions, but that right is not unconditional. Carriers must stay within the bounds of good faith, giving adequate regard to the policyholders’ interests.

Policyholders must vigilantly monitor their carriers’ defense and settlement decisions to ensure that their interests are being protected and, if they are not, be prepared to exercise their rights.

Even if the carrier controls defense and settlement decisions, a policyholder’s active participation in its defense is often critical to protecting against harm not covered by insurance. For example, while a defending insurer often gets to decide whether to settle or try the case, the policyholder may face serious reputational harm if it is not resolved before trial – harm that the policy does not cover, and to which the carrier may be indifferent. The policyholder must make sure the insurer understands that its duty of good faith includes an obligation not to allow collateral damage to the insured’s interests from its decisions.

4. WHETHER THE POLICYHOLDER MUST CONTRIBUTE TO A SETTLEMENT. Even when a carrier is providing a complete defense, it may turn to its policyholder in certain circumstances to demand a significant contribution to the settlement.

Carriers often contend that part of the settlement is excluded from coverage and demand that the policyholder contribute for “uncovered” portions.

Policyholders can guard against this scenario, or at a minimum be prepared for the confrontation it will generate, by anticipating any coverage defenses the carrier may raise. Carriers are required to inform the policyholder of potential coverage defenses well before the settlement stage in the reservation of rights letter that is typically issued when the carrier accepts the defense of the suit. The reservation of rights letter

serves as a roadmap for sophisticated policyholders to follow in anticipating, and heading off, these gambits by the carrier.

The policyholder must be prepared to oppose these efforts and avoid or minimize its settlement contribution.

This is another area where it is to a policyholder’s advantage to have monitoring counsel and/or coverage counsel actively involved in the matter.

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5. DISPUTES OVER WHETHER COSTS ARE DEFENSE OR INDEMNITY COSTS. This type of dispute typically arises in the environmental liability context, when a policyholder incurs attorneys’ fees in responding to federal or state regulatory demands to investigate and clean up contamination rather than in defending against a courtfiled lawsuit. Even in this instance, legal costs incurred in dealing with regulators are typically recognized as defense costs. However, the bulk of the expenses a policyholder typically bears when dealing with regulators are not attorneys’ fees, but rather the costs of engaging an environmental consultant to investigate and, if necessary, remediate the contamination or take other corrective action.

Whether environmental consultant costs count as defense or indemnity costs could make a big difference in the scope of your insurance recovery in at least two respects. First, liability policies with a duty to defend frequently agree to pay defense costs in addition to the policy limits, and defense costs are not subject to those limits. A carrier has an incentive to count environmental consultant expenses as indemnity costs that exhaust the policy limits and extinguish its coverage obligations faster, rather than as limitless defense costs paid outside policy limits. Second, the duty to defend is generally broader than the duty to indemnify. Carriers frequently agree to defend a suit but reserve the right to deny any obligation to indemnify the policyholder for a settlement or judgment. By classifying environmental consultant expenses as indemnity rather than defense, a carrier may be planning to avoid these costs altogether by denying a duty to indemnify. When these expenses are included in the insurer’s duty to defend, which survives even if it refuses to indemnify some component of loss, the carrier cannot evade its duty to pay them.

A general rule of thumb that many courts have adopted (subject to the wording of the policies and the facts of a particular case) is to treat the costs to investigate contamination presumptively as defense costs akin to expert fees, and to treat costs to implement the remediation or other corrective action as an indemnity expense akin to payment of a judgment. For example, under New York law, “[p]olicyholders and insurance companies generally expect that a careful investigation of the insurer’s potential liability will be provided by

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the insurer pursuant to its duty to defend.”6 Similarly, under Minnesota law, “the fact that otherwise allowable defense costs serve the dual purpose of complying with the RFRA does not, in our estimation, render such costs indemnity costs.”7 This rule of thumb does not neatly sort all consultant costs into one category or the other, and there are some costs that are frequently disputed, such as the cost of conducting a feasibility study to evaluate various remedial options to select the most appropriate technique. Policyholders typically argue that these costs are necessary to effectively negotiate a remedy with the regulators and should be treated as a defense cost. Carriers may argue that costs incurred to select a remedy are themselves remedial. Jurisdictions are split on this issue.8 Depending on the wording of the policies, the facts of a particular case, and the applicable law, the policyholder may be able to maximize its recovery by pushing as much of the environmental consultant costs as possible into the carrier’s duty to defend.

6. PRE-NOTICE COSTS. Even where an insurance company accepts the duty to defend, it may still deny an obligation to pay defense or mitigation costs the policyholder incurred before the carrier was notified. State law varies on whether, and under what circumstances, these pre-tender costs are covered. Some states allow partial or complete recovery of these costs under certain circumstances, such as when the carrier cannot show that it was “prejudiced” by the pre-notice activities undertaken without its knowledge or consent.9 Other states have a bright-line rule that pre-notice costs are not recoverable.10 Knowing which state’s law applies, and knowing your rights under that state’s law, are critical to an understanding of whether the policyholder has an opportunity to recover pre-notice costs from the carrier.

7. RECOUPMENT OF DEFENSE COSTS. Carriers often purport to reserve a right to reimbursement of monies spent defending the policyholder if, ultimately, it is determined that the carrier does not owe a duty to indemnify. Policyholders must promptly and expressly object to any such reservation of this purported right, often found in the reservation of rights letter. Unless there is an express recoupment provision in the policy, there should be no

National coordinating counsel oversees the defense of all such suits to ensure that discovery positions and expert testimony are consistent across cases and to avoid taking inconsistent positions on litigation and settlement strategy.

Endicott Johnson Corp. v. Liberty Mut. Ins. Co., 928 F. Supp. 176, 184 (N.D.N.Y. 1996).

Domtar v. Niagara Fire Ins. Co., 563 N.W.2d 724, 738 (Minn. 1997).

Compare Hi-Mill Mfg. Co. v. Aetna Cas. & Surety Co., 884 F. Supp. 1109, 1117 (E.D. Mich. 1995) with Spokane County v. American Re-Ins. Co., 1993 U.S. Dist. LEXIS 21038, at *7 (E.D. Wash. May 12, 1993).

9 E.g., TPLC, Inc. v. United Nat’l Ins. Co., 44 F.3d 1484, 1492 (10th Cir. 1995) (“in the absence of a showing of prejudice, the insurer’s duty to defend includes the duty to reimburse for reasonable costs of defense incurred prior to notice”) (Pennsylvania law); Peavey Co. v. MV ANPA, 971 F.2d 1168, 1178 (5th Cir. 1992) (“Zurich cannot argue that it did not benefit from Degesch’s investigative efforts prior to notification.... Therefore, we find that Degesch’s attorney fees prior to notice are recoverable.”); Amtrol, Inc. v. Tudor Ins Co., 2002 U.S. Dist. LEXIS 18691, at *35-36 (D. Mass. Sept. 10, 2002) (“The insurers must establish that Amtrol’s payments and repair/replacement costs prior to notification in 1999 actually caused them prejudice.”)

10 E.g., Domtar, Inc. v. Niagara Fire Ins. Co., 563 N.W.2d 724, 739 (Minn. 1997); Truck Ins. Exch. v. Unigard Ins. Co., 79 Cal. App. 4th 966, 977 (2000).

6 7

8

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basis for a carrier to impose such a requirement, and courts in many (but not all) jurisdictions have agreed.11 A reservation of rights letter that includes a reservation of a purported right to recoup defense costs should be treated as a red flag, and the policyholder should expressly object to the carrier’s attempt to reserve that purported right.

8. NATIONAL COORDINATING COUNSEL. For policyholders facing recurring liability exposures throughout the country, such as asbestos or toxic tort suits, it may be essential to the policyholder’s overall defense strategy to appoint attorneys from one or more firms to serve as national coordinating counsel. National coordinating counsel oversees the defense of all such suits to ensure that discovery positions and expert testimony are consistent across cases, and to avoid taking inconsistent positions on litigation and settlement strategy. Carriers sometimes contend that the duty to defend does not include a duty to hire and pay national coordinating counsel; rather, their obligation extends only to hiring local counsel to defend each individual suit without regard to coordination.

Insurers of the product liability of large corporations usually are experienced enough in this line of business that they recognize the value of coordinating counsel and are willing to pay for it. Relatively few jurisdictions have addressed whether coordinating counsel fees are covered, but those that have tend to recognize this as a “reasonable and necessary” defense cost the carrier must pay.12

what extent the policyholder must contribute a portion of the defense and indemnity costs for uninsured periods, self-insured periods or periods for which a carrier has declared bankruptcy.

Multiple-carrier situations can also complicate the potential for conflicting interests and objectives among the carriers. Issues discussed above, such as whether the policyholder or the carrier has the right to select counsel and control the defense, can become much more difficult to resolve, especially when different carriers are agreeing to defend under different conditions and reservations and, potentially, different policy language. If the policyholder is unaware of its rights on these issues and does not aggressively protect them, it may end up saddled with a significantly larger contribution than it is obligated to pay. Having a risk manager, in-house counsel or outside coverage counsel actively advocate for the policyholder’s interests is essential in navigating the pitfalls created when multiple carriers are involved and in maximizing benefits from the carrier group.

CONCLUSION In summary, even after you have obtained a carrier’s agreement to defend and cover a lawsuit, in many instances your work has only just begun. The issues above can be worth millions of dollars to policyholders. It is worth protecting your company’s rights by identifying and addressing these issues when – and possibly before – they arise.

9. MULTIPLE-CARRIER SITUATIONS. All of these issues become more complex when more than one carrier owes an obligation to defend or indemnify the policyholder in the same suit. These situations often arise for long-tail claims, which trigger a multitude of historical primary and excess policies issued by different carriers over a period of several years. Fundamental questions arise, such as how defense and indemnity costs are apportioned or allocated among carriers, and the policyholder’s ability to select which policies are triggered and exhausted and in what order. The order of triggering and exhausting can significantly impact whether and to

John P. Fischer is a partner in Barnes & Thornburg’s Indianapolis office. 317-231-7355 or john.fischer@btlaw.com

E.g., Am. & Foreign Ins. Co. v. Jerry’s Sport Center, 2 A.3d 526, 541 (Pa. 2010); Welch Foods Inc. v. Nat’l Union Fire Ins. Co., 2011 WL 576600, at *3 (D. Mass. 2011). But see Buss v. Superior Court, 16 Cal. 4th 35, 57 (1997).

12 E.g., Watts Water Tech., Inc. v. Fireman’s Fund Ins. Co., 22 Mass. L. Rptr. 659 at *24 (Mass. Super. Ct. 2007) (“The insurers must pay for legal work performed at a reasonable cost...regardless of whether that work is performed by a single law firm or allocated among national counsel and various local counsel.”).

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COVERAGE MAY EXIST FOR COMPANIES FACING ALLEGATIONS RELATED TO SEXUAL ABUSE

By Steven P. Inman, II

On Aug. 14, 2019, a provision of New York’s new Child Victim Act went into effect that lifted the statute of limitations on childhood sexual abuse claims for a one-year period (until Aug. 14, 2020). Thereafter, child sex abuse victims will have until age 55 to file lawsuits. The Child Victim Act has reportedly already resulted in a flood of new lawsuits for sexual abuse and related claims. Additionally, legislatures in multiple other states have already enacted, or are actively considering, similar laws.

Consequently, sexual abuse-related claims against companies, such as negligent hiring, negligent supervision, negligent retention and negligent failure to warn, will likely become more frequent. Companies should consider taking the time now to understand how their insurance policies (including legacy policies) may respond to such claims, and they should be prepared to notify their carriers immediately of any claims or potential claims that they become aware of, pursuant to the notice provisions in those policies.

Sexual abuse-related claims against companies, such as negligent hiring, negligent supervision, negligent retention and negligent failure to warn, will likely become more frequent.

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When a company receives a demand or complaint alleging that one of its employees has committed sexual abuse, it may mistakenly believe that due to the intentional and abhorrent nature of the alleged act, no coverage exists for the victim’s claims against the company. While it is generally true that no coverage exists for the abuser because public policy bars coverage for intentional infliction of an injury, companies often have coverage for claims related to sexual abuse that allege negligent – rather than intentional – supervision, hiring or other conduct that does not amount to complicity in the abuse. Companies should consider it a best practice not to leave policy benefits on the table that could pay defense expenses and be used to pay settlements or judgments (money that can protect innocent shareholders and compensate victims). An Ohio court described the scope of coverage in Doe v. Shaffer, 90 Ohio St. 3d 388, 393 (2000), holding that “the intentions of the molester are immaterial to determining whether the allegedly negligent party has coverage.”

Different kinds of businesses will have different potentially applicable insurance policies depending on the context of the claim. For example, directors and officers liability policies may cover claims for economic losses by investors relating to a drop in company value due to an abuse claim, but for most companies, coverage for negligence claims related to sexual abuse are most likely to be covered under commercial general liability policies. Claims related to sexual abuse typically fall within the bodily injury and/or personal injury coverage grants of those policies.

Commercial general liability policies are “occurrencebased” policies, meaning that the policy in effect during the policy period in which the occurrence giving rise to the claim took place – rather than the policy in effect when the claim was made or suit was filed – will be the policy that applies. Many of the lawsuits brought under the Child Victims Act and similar laws will pertain to conduct that occurred many years ago. Companies likely will need to locate legacy policies to determine which carriers may respond to these claims, then notify those carriers appropriately.

To the extent that a legacy policy cannot be located, courts generally permit insureds to use secondary evidence of an insurance policy (i.e., documents referring to the policy) to prove the existence of coverage. Courts have set the precedent for establishing that coverage existed. In Burroughs Wellcome Co. v. Commercial Union Ins. Co., 632 F. Supp. 1213, 1222 (S.D.N.Y. 1986), the U.S. District Court for the Southern District of New York held that the insurer had a duty to defend after the insured used secondary evidence, including policies from other years, 20 | btlaw.com

certificates of insurance, letters discussing coverage, letters discussing renewal of coverage, portions of policies, letters referring to other claims and excess policies that referred to the lost policies, to prove the potential for coverage under pre-1967 policies. To avoid the expense of having to litigate the existence of coverage, every effort should be made to retain applicable policies in an easily accessible place.

What’s in a Number…of Occurrences?

An “occurrence-based” policy covers bodily injury resulting from something done accidentally, and has one policy limit for a single occurrence (the per-occurrence limit) and another, usually higher limit applicable to a series of occurrences (the aggregate limit). In cases involving multiple instances of abuse or multiple victims, the carrier and the insured may dispute the number of occurrences that took place. The number of occurrences is important because it determines how many per-occurrence policy limits may be available to the insured within the aggregate limit to pay a settlement or judgment. But the number of occurrences may also determine how many deductibles or self-insured retentions the insured must pay. Additionally, occurrences taking place over multiple policy years may trigger coverage under multiple policies, such as in Interstate Fire & Cas. Co. v. Archdiocese of Portland in Oregon, 35 F.3d 1325, 1331 (9th Cir. 1994), where the court held that “because the parties do not contest that [the victim] was exposed to the negligently supervised priest in each of the four policy periods, we conclude that [the victim’s] claim implicates four occurrences.”

Courts are split on how the number of occurrences that are triggered in a sexual abuse case involving multiple acts of abuse to a single victim or multiple victims. While different policies have different definitions of “occurrence,” the term “occurrence” is often defined as “an accident neither expected nor intended, including continuous or repeated exposure to substantially the same general harmful conditions.” In Roman Catholic Diocese of Brooklyn v. National Union Fire Insurance Co. of Pittsburgh, Pa., 991 N.E. 2d 666 (2013), the diocese argued that it should not have to pay multiple self-insured retentions because the “continuous or repeated exposure” language in the definition of “occurrence” required that the separate instances of abuse (which occurred at different times and in different locations) be aggregated into a single claim.

In rejecting the diocese’s argument, the New York Court of Appeals stated, “In our view, sexual abuse does not fit neatly into the policies’ definition of ‘continuous or repeated exposure’ to ‘conditions.’ This sounds like language designed

to deal with asbestos fibers in the air, or lead-based paint on the walls, rather than with priests and choirboys.” Instead, the court determined the number of occurrences by applying the “unfortunate event test”: it considered “whether there is a close temporal and spatial relationship between the incidents giving rise to injury or loss, and whether the incidents can be viewed as part of the same causal continuum, without intervening agents or factors.”

The court found a lack of temporal and spatial closeness (based on the different times and locations) and that the instances of abuse lacked a singular causal continuum.

Therefore, it found that each instance of abuse constituted a separate occurrence. In contrast, courts in other jurisdictions have applied a “causal approach” to determining the number of occurrences and have held that separate instances of molestation – even involving separate victims – may be considered one “occurrence” when premised on an entity’s negligence. In a Nevada case, Washoe Cty. v. Transcon. Ins. Co., 110 Nev. 110 Nev. 798, 801 (1994), the court found “each of the separate instances of molestation arises from the same proximate cause vis-a-vis the County: namely, the County’s alleged negligence in the process of licensing Papoose. We conclude that the County’s negligence... constitutes a single occurrence for purposes of liability.”

Thus, how the number of “occurrences” is determined differs from jurisdiction to jurisdiction.

Insurance carriers have also sought to use the definition of “occurrence” to avoid coverage for claims related to sexual abuse by arguing that abuse cannot be an “occurrence” because it cannot be “neither expected nor intended” or “an unexpected, unforeseen, or undesigned happening or consequence from either a known or an unknown cause,” as policy definitions of “occurrence” typically require.

That argument was made in Liberty Surplus Ins. Corp. v.

Ledesma & Meyer Constr. Co., 5 Cal. 5th 216, 221–22 (2018).

However, a number of courts have held that whether the occurrence or accident is expected, intended, foreseen or designed must be evaluated from the standpoint of the insured, including in a California case, Minkler v. Safeco Ins. Co. of America, 49 Cal. 4th 315 (2010). That court ruled that insureds that have not committed intentional acts have a reasonable expectation of coverage, even when another insured has committed intentional acts for which the noncomplicit insured is alleged to be responsible. The court in Liberty Surplus also held that “a policy providing a defense and indemnification for bodily injury caused by an accident promises coverage for liability resulting from the insured’s negligent acts.”

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Policy Language Revisions Not surprisingly, a number of insurance carriers have revised their policies to attempt to preclude coverage for all insureds when any of the insureds commits an intentional act. For example, they have revised language precluding coverage for injuries “expected or intended by the insured” to say “expected or intended by an insured” and changed exclusions for claims arising from illegal acts committed by “the insured” to claims arising from illegal acts committed by “an insured.” A split of authority exists among courts as to the effectiveness of such revisions, particularly when a policy also contains a “severability provision” or “separate insurance” provision. Such clauses, which are common in liability policies, require that the insurance apply separately to each insured.

Thus, coverage for one insured may be preserved by the severability provision despite an exclusion for intentional acts that precludes coverage for another insured.

For example, in Minkler, a plaintiff sued his baseball coach for sexual abuse and the coach’s mother for negligent supervision. Some of the abuse had occurred in the mother’s home, and the coach was listed as an additional insured on his mother’s homeowners insurance policies.

The policies contained an exclusion for bodily injury “expected or intended by an insured or which is the forseeable result of an act or omission intended by an insured.” However, the policies also included severability provisions that stated, “This insurance applies separately to each insured.” After obtaining a $5 million default judgment against the mother, the plaintiff sued the carrier, alleging that it had wrongfully denied coverage for the mother based on the exclusion.

The carrier removed the case to federal court, where it prevailed on a motion to dismiss. On appeal, the Ninth Circuit directed the following question to the California Supreme Court: Where a contract of liability insurance covering multiple insureds contains a severability clause, does an exclusion barring coverage for injuries arising out of the intentional acts of ‘an insured’ bar coverage for claims that one insured negligently failed to prevent the intentional acts of another insured?

The California Supreme Court answered that it did not, and held that because of the severability provision, the mother’s coverage must be analyzed “on the basis of whether she herself committed an act or acts that fell within the intentional act exclusion.” Thus, coverage may exist for a negligence claim related to sexual abuse regardless of the “an insured” language and the intentional acts of another insured.

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Courts have reached the opposite result in other jurisdictions. For example, in Am. Family Mut. Ins. Co. v.

Wheeler, 287 Neb. 250, 259 (2014), the Supreme Court of Nebraska declined to follow Minkler and affirmed summary judgment in favor of the carrier when an insured was sued for negligence in connection with a sexual assault committed by his son, who was also an insured under his policies. While the policies contained severability provisions, the court held that “applying the insurance separately to each insured, as the severability clause requires, does not change that the exclusions reference ‘an insured’ or ‘any insured.’” Further, a growing number of policies now contain broad exclusions for claims arising out of sexual abuse regardless of who committed the abuse. The extent to which such exclusions apply to preclude coverage will depend on how they are worded and how broadly courts interpret them.

Claims related to sexual abuse raise complex issues, the outcomes of which may differ by jurisdiction and policy language. The general rule remains, however, that “an insurer must provide coverage and a legal defense to an insured where a complaint alleges that an employer was negligent in hiring and supervision of an employee who subsequently committed an intentional tort,” such as sexual abuse, as stated in Silverball Amusement, Inc. v. Utah Home Fire Ins. Co., 842 F. Supp. 1151, 1165 (W.D. Ark.), aff’d, 33 F.3d 1476 (8th Cir. 1994). The court in Liberty Surplus said, “Absent an applicable exclusion, employers may legitimately expect coverage for such claims under comprehensive general liability insurance policies, just as they do for other claims of negligence.”

The ruling in Liberty Surplus went on to espouse that despite the egregious and destructive nature of sexual abuse and “society’s interest in providing an incentive for employers to take precautions against sexual abuse by their employees,” insurance coverage is generally available to companies for claims related to sexual abuse because “the threat of liability for negligent hiring, retention, and supervision is a significant deterrent even when insurance coverage is available.” With this admonition in mind, companies facing claims related to sexual abuse should immediately provide notice to their carriers in the knowledge that depending on which state’s law applies, an insured not complicit in the abuse, sued for negligence in allowing it to happen, should be covered.

Steven P. Inman II is of counsel in Barnes & Thornburg’s San

Diego office. 619-321-5009 or steve.inman@btlaw.com

BUILDING AN INSURANCE BAD FAITH CASE: OBTAINING DISCOVERY OF THE INSURER’S SUBJECTIVE STATE OF MIND THROUGH LOSS RESERVES, REINSURANCE COMMUNICATIONS AND SIMILAR CLAIMS

By Andrea Warren Bad faith claims pose a unique set of risks to insurance companies and expose them to significant extra-contractual damages, including attorneys’ fees, consequential damages, double or triple damages and other punitive damages depending on the jurisdiction in which the policyholder files its bad faith action.

Insurers facing bad faith claims feel vulnerable because their internal operations and decision-making processes become subject to intense scrutiny. Their claims handlers’ state of mind in adjusting the claim and making coverage decisions becomes a key issue, with policyholders alleging that they acted unreasonably, dishonestly or improperly in processing, investigating, paying or settling a claim.

As a result, insurers strongly resist discovery into how they adjust claims and make coverage decisions. This creates a pricey, sometimes uphill, battle for policyholders. Yet discovery remains one of the best methods for gaining candid insight into an insurer’s state of mind at the time it adjusted and made decisions about the claim. Discovery into the insurer’s loss reserves, reports to its reinsurers and its actions and decision-making in similar “other claims” often shows the insurer’s real-time thoughts and decisionmaking processes.

There is no uniform standard for proving bad faith, but many jurisdictions consider the insurer’s subjective state of mind.

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Some jurisdictions have a heightened standard for proving bad faith, which requires policyholders to show conscious wrongdoing and a state of mind reflecting dishonest purpose, moral obliquity or ill will.1 Other jurisdictions require the policyholder to show that the insurer either knew or recklessly disregarded the fact that its denial or failure to pay was unreasonable,2 which includes a subjective analysis as to whether the insurer committed consciously unreasonable acts.3 Even jurisdictions limiting the bad faith analysis to objective reasonability consider the insurer’s subjective intent.4 And regardless of the bad faith standard, many jurisdictions require proof of malice before awarding punitive damages for bad faith-making evidence of subjective intent extremely valuable.5 Discovery into the insurer’s state of mind during the relevant time period also may defeat an insurer’s motion for summary judgment on the bad faith claim. Insurers often attempt to hide behind the “reasonable dispute” or “genuine dispute” doctrine, which holds that an insurer mistakenly denying coverage or delaying payment of policy benefits avoids bad faith liability if the basis of its actions was based on a genuine dispute with the insured about the existence of coverage or amount of liability.

Insurers often attempt to show reasonableness in a vacuum, without reference to the history of the claim or the mental state of the adjuster at the time he or she denied coverage. Insurers rely on retained experts and litigation counsel to offer after-the-fact justifications of the way their adjusters acted in denying coverage. The relevant inquiry, however, is whether that decision was reasonable at the time it was made,6 a question that can only be answered through discovery of the adjuster’s claim file and other documents, such as loss reserves and reports to reinsurers, detailing the adjuster’s actions and decision-making processes in real time.

Loss Reserves: How the Adjuster Internally Evaluated Potential for Liability Insurance companies are required by state statute or regulation to set loss reserves for each claim. Loss reserves are “the amount anticipated [by the insurer] to be sufficient to pay all obligations for which the insurer may be responsible under the policy with respect to a particular claim.” See, e.g., Spahr v. Amco Ins. Co., 2010 WL

/ Pearman v. Stewart Title Guar. Co., 108 N.E.3d 342, 348 (Ind. Ct. App. 2018). / White Mountain Communities Hosp. Inc. v. Hartford Cas. Ins. Co., 2015 WL 1755372, at *4 (D. Ariz. 2015).

3 / Id. 4 / L.A. Lakers, Inc. v. Fed. Ins. Co., 869 F.3d 795, 812 (9th Cir. 2017).

5 / Praetorian Ins. Co. v. Western Milling, LLC, 2017 WL 4284717, at *9 (E.D. Cal. 2017).

6 / Century Surety Co. v. Polisso, 139 Cal. App. 4th 922, 949 (2006).

1

2

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11459909, at *1 (C.D. Cal. Sept. 29, 2010) (emphasis added).

Loss reserves can reveal an unvarnished assessment of coverage that may differ substantially from what the insurer and its experts assert in litigation.

Insurers uniformly refuse to disclose reserves, and lodge a litany of relevancy and privilege objections in support of this refusal. They argue, for example, that reserves are not admissions and that they should not be penalized for setting aside capital to meet a claim in what they characterize as the unlikely event of coverage. The case law, however, is on the side of the policyholder.

“The overwhelming majority of courts [] find reserves discoverable, especially in cases involving bad faith claims.” Central Ga. Anesthesia Servs., P.C. v. Equitable Life Assurance Soc’y of U.S., 2007 WL 2128184, at *2 (M.D. Ga. July 25, 2007); OOIDA Risk Retention Grp., Inc. v. Bordeaux, 2016 WL 427066, at *10 (D. Nev. Feb. 3, 2016) (“[The] bulk of cases to consider the issue have concluded that reserve information is relevant to whether an insurer acted in bad faith”); Culbertson v. Shelter

Mut. Ins. Co., 1998 WL 743592, at *1 (E.D. La. Oct. 21, 1998) (endorsing the line of cases “which hold that reserve information is discoverable where a claim of bad faith is asserted”); Lexington Ins. Co. v. Swanson, 240 F.R.D. 662, 667-68 (W.D. Wash. 2007) (citing treatise observing that “to this writer’s knowledge, no case has held that reserves evidence is irrelevant in a bad faith case”).

Many courts have found reserves relevant and discoverable precisely because they can shed light on the insurer’s subjective state of mind and subjective

assessment of liability.7 Courts often find that, where the insurer has denied coverage and refused a defense, the very fact that a reserve had been set, and certainly if a high reserve had been set, shows that the insurer knew that the potential for coverage existed – evidencing that it knowingly and in bad faith violated its duty to defend.8 Even where the insurer has acknowledged coverage, courts have found that reserves may show a seismic divergence between the insurer’s genuine valuation of the claim and its position communicated to the policyholder, reflecting a lack of good faith in settling or paying the claim.9 Other courts have held that reserves may show that the insurer performed a negligent or uninformed evaluation of the claim, also evidencing bad faith.10 Insurers argue that, even if reserves are relevant, they are only relevant in the context of third-party claims. Again, this is not so. Courts have found reserves relevant in both first- and third-party claims. Some have even held that the relevance of reserve information is even more pronounced in first-party claims.11 Insurers next argue that, even if relevant, reserves are shielded from production by the work product doctrine.

To qualify as work product, the insurer’s document must have been created “in anticipation of litigation” rather than in the ordinary course of business. Courts have found that, generally, an insurer cannot anticipate litigation until it denies coverage and, until that point, an insurer’s investigation of the claim – including its setting of loss reserves – is part of its ordinary course of business and, therefore, not protected by the work product doctrine.12 Reserves are set as part of routine adjusting pursuant to state statutes and regulations, not prepared “in anticipation of litigation.” Courts have recognized this and refused to shield reserves from disclosure based on the work product doctrine.13 / ITT Corp. v. Travelers Cas. & Sur. Co., 2017 WL 3783257, at *6 (D. Conn. 2017); Pinnacle Med. Servs., Inc. v. Hanover Ins. Co., 2008 WL 11353743 at *3 (E.D. La. 2008); Flintkote Co. v. Gen. Accident Assurance Co. of Canada, 2009 WL 1457974, at *3 (N.D. Cal 2009).

8 / Everest Nat’l Ins. Co. v. Santa Cruz Cnty. Bank, 2016 WL 6311876, at *1 (N.D. Cal. 2016); Trinity East Energy, LLC v. St. Paul Surplus Lines Ins. Co., 2013 WL 12124022, at *3 (N.D. Tex. 2013); see also 17A COUCH ON INSURANCE 3D § 251:29 (3rd ed.

June 2019 Update).

9 / Park-Ohio Holdings Corp. v. Liberty Mut. Fire Ins. Co., 2015 WL 5055947, at *4 (N.D. Ohio 2015); Fay Ave. Props., LLC v. Travelers Prop. & Cas. Co., 2014 WL 1333669, at *3 (S.D. Cal. 2014); Kirchoff v. Am. Cas. Co., of Reading, Pa., 997 F.2d 401, 405 (8th Cir. 1993).

10 / Nat’l Union Fire Ins. Co. of Pittsburgh, PA v. H&R Block, Inc., 2014 WL 4377845 (S.D.N.Y. 2014); Omega Protein Corp. v. Lexington Ins. Co., 2007 WL 519686, at * 2 (W.D. La. 2007); Savoy v. Richard A. Insurer Trucking, Inc., 176 F.R.D. 10, 12 (D. Mass.

1997).

11 / Bishelli v. State Farm Mut. Auto. Ins. Co., 2008 WL 280850, at *2 (D. Colo. 2008); U.S. Fire Ins. Co. v. Bunge N. America, Inc., 244 F.R.D. 638 (D. Kan. 2007).

12 / Barnard Pipeline, Inc. v. Travelers Prop. Cas. Ins. Co. of Am., 2014 WL 1576543, at *4 (D. Mont. 2014); Elec. Power Sys. Int’l, Inc. v. Zurich Am. Ins. Co., 2016 WL 3997069, at *3 (E.D. Mo. 2016).

13 / ContraVest Inc. v. Mt. Hawley Ins. Co., 273 F. Supp. 3d 607, 624-25 n. 17 (D.S.C. 2017); 866 E. 164th St., LLC v. Union Mut. Fire Ins. Co., 2016 WL 6901321, at *2 (S.D.N.Y. 2016).

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Fall 2019 Corporate Policyholder | 25

Reinsurance Communications: What the Insurer Told Its Own Insurer About Potential Liability for the Claim

because the insurer’s communications with reinsurers may be the only reliable indication of the carrier’s mental state and whether it acted in bad faith.20

Communications between an insurer (the “cedent”) and its reinsurer may also provide a treasure trove of insight into the insurer’s state of mind. Reinsurers expect their cedent insurers to timely report claims and communicate regarding the potential for liability and coverage defenses. Reports to reinsurers often contain analysis of risk exposure and information regarding valuation of the claim and settlement opportunities, including reports from counsel regarding a coverage analysis. These reports show the insurer’s realtime analysis of the claim, which may drastically differ from its characterization in subsequent litigation of its adjuster’s investigation of and decisions concerning a denied claim based on a sanitized record.

Insurers also argue that reports to their reinsurers are protected by the attorney-client privilege because they contain advice of coverage counsel concerning coverage and available coverage defenses. Again, courts have rejected this argument, finding either that the privilege never attached or that it was waived upon sharing the document with a reinsurer. Also, to the extent that outside coverage counsel acted as a claims adjuster in providing this advice or the insurer used a coverage attorney to conduct its usual claims handling process, the privilege will not attach.21 Even if privilege applies, however, the insurer generally is held to have waived it once the document is shared with the reinsurer.22

As with reserves, courts have consistently held that reinsurance communications are relevant and discoverable.14 Courts have held that these communications indicate whether the cedent insurer believed its policies covered the claim and acted inconsistently with that knowledge.15 Courts have also held that these communications explain the insurer’s reasons for granting or denying coverage16 and may be probative of the relative adequacy of the insurer’s investigation of the claim.17

Insurers attempt to avoid waiver by relying on the “common interest” doctrine to argue that privilege is not waived.23 The common interest doctrine, however, requires a joint legal interest. Courts regularly hold that insurers and their reinsurers may share a joint financial or commercial interest, but this is not the same as a joint legal interest, meaning any privilege is waived once counsel’s report is shared with the reinsurer.24 Even if there is a joint legal interest, there also must be evidence of an agreement between an insurer and its reinsurer that establishes a cooperative and common enterprise toward an identical legal strategy as a matter of legal necessity, beyond a mere contractual authorization for the reinsurer to participate in litigation.25

Insurers often assert blanket work product or attorneyclient protections over their communications with reinsurers. Courts regularly refuse these protections, finding that the communications are either not protected or that any protection was waived.18 Courts have recognized that cedent insurers’ reports to reinsurers are created in the ordinary course of business pursuant to contractual obligations between the cedent and the reinsurer and are therefore not protected by the work product doctrine.19 Even documents qualifying for work product protection are otherwise discoverable as long as the policyholder shows a “substantial need” for the documents, which often exists in bad faith claims,

Other Claims: How the Insurer Evaluated and Valued Similar Claims by Other Policyholders Discovery about the decisions an insurer has made in similar claims submitted by similarly situated policyholders also helps build a bad faith case. “Other claims” discovery may show that an insurer acted arbitrarily or unreasonably

/ Edward H. Widmann , 2 LAW & PRAC. OF INS. COV. LIT. § 17.71 (2019 Update) (“Generally, the courts have held communications to the reinsurer are not privileged and are subject to discovery.”)

15 / Northrop Grumman Corp. v. Factory Mut. Ins. Co., 2007 WL 9627647, at *3 (C.D. Cal. 2007); Saldi v. Pail Reserve Life Ins. Co., 224 F.R.D. 169, 197 (E.D. Pa. 2004); Nat’l Union Fire Ins. Co. of Pittsburgh v. Stauffer Chem. Co., 558 A.2d 1091, 1096-97 (Del. Super. Ct. 1989).

16 / ContraVast Inc., supra, 273 F. Supp. 3d at 623.

17 / Bunge, supra, 244 F.R.D. at 643.

18 / Edward H. Widmann, 2 LAW & PRAC. OF INS. COV. LIT. § 17.71 (2019 Update).

19 / Front Royal Ins. Co. v. Gold Players, Inc., 187 F.R.D. 252, 257 (W.D. Va. 1999); Progressive Cas. Ins. Co. v. F.D.I.C., 302 F.R.D. 497, 502 (N.D. Iowa), aff’d, 49 F.Supp.3d 545 (N.D. Iowa 2014).

20 / Skinner v. Progressive Mountain Ins. Co., (N.D. Ga. 2013); Camacho v. Nationwide Mut. Ins. Co., 287 F.R.D. 688, 700 (N.D. Ga. 2012).

21 / First Aviation Serv., Inc. v. Gulf Ins. Co., 205 F.R.D. 65, 68-69 (D. Conn. 2001); Mission Nat’l Co. v. Lilly, 112 F.R.D. 160, 163 (D. Minn. 1986).

22 / 99 Wall Dev. Inc. v. Allied World Spec. Ins. Co., 2019 WL 2482356, at *4 (S.D.N.Y. 2019).

23 / Id. 24 / See, e.g., Bancinsure, Inc. v. McCaffree , 2013 WL 5769918, at *7 (D. Kan. 2013); Fireman’s Fund Ins. Co. v. Great Am. Ins. Co. of New York, 284 F.R.D. 132, 139-40 (S.D.N.Y. 2012); Progressive Cas. Ins. Co. v. Fed. Deposit Ins. Corp., 49 F. Supp. 3d 545, 558 (N.D. Iowa 2014).

25 / See, e.g., Progressive, supra, 49 F. Supp. 3d at 558.

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by denying the claim at issue but covering a substantially similar claim submitted by another policyholder under the same or similar facts and policy. Courts across the nation have found that “other claims” are relevant and discoverable in bad faith cases, as they may show inconsistent interpretations of substantially similar language26 and inconsistent application of exclusions and conditions.27 These documents are relevant and discoverable.

Insurers fight hard to avoid “other claims” discovery.

Beyond relevancy objections, insurers contend that such requests are unduly burdensome because they do not keep records of claims by policy type, by substantive positions taken or by facts on which the claim is based.

Experience teaches that all of these assertions are inaccurate in some manner. Insurers are regulated by the laws and regulations of the states in which they do business, and many state insurance regulations require insurers to maintain records of claims by lines of business so that state examiners can perform audits.

In each business line, there is usually a small handful of fact patterns and liability assertions that underwriters sell the specific insurance product to cover.28 If an insurer truly had no way of identifying why it paid claims falling into these subcategories, it would have no statistical means of

assessing whether the line of business was profitable or whether it needed to add or remove coverage limitations.

Insurance companies are some of the most prolific generators of statistics in the world. An insurer’s assertion that it cannot identify similar claims under similar policies without expansive efforts often lacks credibility. Moreover, the fact that an insurer maintains its claim files in a manner that makes access difficult is not a defense to discovery.

An insurer cannot avoid discovery by failing to store or organize its files.29 Loss reserves, reinsurance communications and “other claims” shed light on the insurer’s subjective state of mind during the relevant time period of its decision-making and, as a result, are often critical to building a bad faith claim that can overcome a motion for summary judgment and prevail at trial. Insureds should fight insurers’ resistance to producing these documents, as their bad faith claims may depend on it.

Andrea Warren is a partner in Barnes & Thornburg’s Indianapolis office. 317-231-6479 or andrea.warren@btlaw.com

/ Trestman v. Axis Surplus Ins. Co., 2008 WL 1930540, at *5 (E.D. La. 2008); Diamond State Ins. Co. v. Utica First Ins. Co., 829 N.Y.S.2d 465, 466-67 (N.Y. App. Div. 2007); Hawkins v.

Allstate Ins. Co., 733 P.2d 1073, 1081 (Ariz. 1987).

27 / See, e.g., Columbian Chems. Co. v. AIG Spec. Ins. Co., 2015 WL 12755711, at *5 (N.D. W. Va. 2015); Owens-Corning Fiberglass Corp. v. Allstate Ins. Co., 660 N.E.2d 765, 767 (Ohio.

Ct. Comm. Pl. 1993); Potomac Elec. Power Co. v. California Union Ins. Co., 136 F.R.D. 1, 3 (D.D.C. 1990).

28 / For example, claims under directors’ and officers’ liability policies issued to public companies almost always concern shareholder class and derivative actions alleging securities fraud and related breaches of fiduciary duty, and those claims divide easily into subcategories such as litigation over alleged misrepresentations of the company’s financial position that caused a stock drop when its true condition became known. Claims under fiduciary liability policies almost always concern mismanagement of an ERISA-qualified employee benefits plan, and subcategories include litigation alleging that fiduciaries overpaid themselves, or co-mingled assets, or failed to keep correct records of employee-related transactions.

29 / Columbian Chems., supra, 2015 WL 12755711 at *5; Vind v. Prudential Ins. Co. of Am., 2009 WL 10673372, at *5 (C.D. Cal. 2009); First Tenn. Bank Nat’l Ass’n v. Republic Mortg.

Ins. Co., 2011 WL 6130808, at *2 (W.D. Tenn. 2011); Nowak v. Lexington Ins. Co., 2006 WL 3613764, at *3 (S.D. Fla. 2006).

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Fall 2019 Corporate Policyholder | 27

INTERVIEW WITH LAURENCE MIDLER CBRE General Counsel

When CBRE General Counsel Laurence Midler took over risk management for the commercial real estate giant 12 years ago, the field was brand new to him.

But as the company swelled from $1.5 billion to $20 billion in revenue, Midler grew right along with it, developing a deep understanding of compliance, enterprise risk management and insurance.

Corporate Policyholder asked Midler about how CBRE handles the insurance recovery process.

CP: Can you talk about your work as general counsel for CBRE, and the degree of responsibility you exert over its purchase of insurance and assertion of claims?

CP: Based on your own experiences and observations, what are the most significant insurance issues confronting CBRE today?

Laurence Midler: When my role changed in 2007, I was a relative novice in the field of risk management, but I was suddenly charged with overseeing a function that was buying tens of millions of dollars in insurance and had 20 different lines. We also maintained (and continue to maintain) a captive insurer, so I was immediately put on its board.

LM: By far the biggest challenge is professional indemnity coverage, and that’s because we’re in an industry that doesn’t have the greatest claims history. I’ve learned insurance relationships become much more stressful when you have claims. A large claim is like a scarlet letter, and it affects coverage dynamics as well as subsequent renewals.

I was pretty green. You assume being a lawyer, you’d know about certain things, but not all lawyers work on matters with real insurance concerns. I was entrusted to learn and take it on, and now I feel like I’ve been around the block for a while. Given how much we’ve grown – we’re cracking through the Fortune 200 – a lot of us who’ve been here for the past decade-plus have had to evolve to serve a company with much more sophisticated and diverse operations.

We’ve never had a claim – other than the slip-andfall variety – during my time with CBRE until the years after the Great Recession. Around 2010-11, we started getting hit by a spate of claims involving our valuation of commercial property at the top of the market in 2006 and 2007. We wrote tens of thousands of appraisals in the lead-up to the financial crisis, some on speculative development and raw land and change-of-use evaluations. Of the pre-recession valuations, we ended

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up with some lawsuits where properties that we had valued were ultimately sold for less or foreclosed. We started getting claims, some on the large side, as did the whole industry. Some competitors exited the business because they couldn’t get insurance.

Since then, we’ve had fewer valuation claims. The mouse made it through the snake, as they say, as those claims matured and were resolved. But even though they have been resolved, we then had a few other large nonvaluation claims. And now we’re facing renewals in the context of a very difficult premium-to-claims ratio, and insurers generally want to stick around only if they can get higher premiums to compensate them for past claims payments. They also look to increase deductibles above the level where they would expect claims.

CP: How important is it to keep insurers apprised of information related to claims?

LM: We spend a lot of time and effort keeping them apprised. When claims hit our policy, when they hit the primary limit, we’re in constant communication with insurers. The ability to go to insurers and say “We’d like to settle this claim and we’d like you to pay” depends on your relationships with the insurers’ claims professionals – and how much they trust that you have done everything they want you to do. The worst-case scenario is calling and telling them we want to settle a case and the insurers don’t have information to evaluate because we haven’t kept them apprised. We take pains to keep our relationships as strong as possible, and yet, sometimes, the insurers still say they don’t have enough information.

That’s not a good situation for us, but it’s an obligation we must get resolved. The insurers sometimes will hire outside litigators at that late stage, and then we’re dealing with a whole new set of skeptics and a new set of requests for information. This is the art and science of insurance claims handling. You’ve got to keep a smile on your face and play ball, because, ultimately, you need the insurers to cover.

CP: Talk about the client-law firm relationship in the context of protecting CBRE in major litigation.

How have you organized your team to manage the defense of a lawsuit that is covered by insurance and the negotiation of disputes with carriers as a claim unfolds?

LM: We have a strong in-house litigation team, but we also hire and rely on outside counsel in larger matters.

When we do, we have a very tight collaborative working

relationship with the counsel as we work through the case. As it relates to insurance, typically, we know more about what our insurance carriers want to see than even our outside counsel does and we’re leading the communications with the insurers. For 90 percent of litigation, we don’t have coverage counsel – but we need it in some large cases (and for the occasional one-off question). It’s the really complex cases where outside coverage counsel becomes important. They’re solely focused on communicating with coverage lawyers for insurers and with issues under the policy.

In one large settlement where there were issues around coverage, we gathered our full team at a settlement conference, including our outside coverage counsel (whom I consider our rabbi when it comes to coverage dynamics). And sometimes, when there’s a case early on in which we’re thinking about putting insurers on notice, we bring coverage counsel on early.

CP: Could you tell us about CBRE’s claims experience with its insurance policies over its long history and how you manage relationships with insurance companies to best promote your company’s interests?

LM: There are two primary times when you deal with insurers: When you’re buying insurance and when you have a claim. You develop relationships primarily when you’re buying. It’s a relationship business and relationships form between risk managers and insurers.

The lawyers typically stay out of it, though I’m that rare lawyer who manages a risk management department.

When claims occur, that’s when we need insurers, and we’d better hope we have a good relationship and foundation to have those discussions about claims.

Now we’re dealing with claims people – and when they think they have an issue, sometimes they’ll hire outside counsel. Not to be cynical, if the insurer can collect premiums and not pay a claim, that would be a great day for the insurer – until word gets around and they’re not getting new customers because they have a reputation of not paying claims.

But if we want to have a reasonably priced insurance program and have capacity to insure our risk, we had better manage risk to minimize claims. You don’t want to buy homeowners’ insurance and leave candles burning by the drapes. Insurers appreciate clients who really take care of basic blocking and tackling around managing claims.

Fall 2019 Corporate Policyholder | 29

A Attack Could Devastate Your Company WILL YOUR INSURANCE COVER IT?

By Carrie Marie Raver

What Is Ransomware?

Ransomware Trends

Ransomware is a form of electronic kidnapping. Typically, cybercriminals use malicious software to gain access to your company’s computer systems or files and block user access. Hackers hold the systems or files hostage using encryption until the victim organization pays a ransom in exchange for the encryption key. The hackers then – if they are “reputable” criminals – supply the organization with a key that permits the organization to access the systems or files encrypted by the software.

Why should companies be concerned about this risk?

Because the frequency and severity of these attacks are on the rise. Hiscox, a liability insurer, recently reported in its Cyber Readiness Report 2019 that “[b]oth the costs and frequency of attacks have increased markedly compared with a year ago.” Another insurer, Beazley Group, reported a “105% increase in the number of ransomware attack notifications against clients compared to Q1 2018.” In the same report, Beazley stated that “in the first quarter of 2019, the average ransomware demand reported to the [Beazley Breach Response] BBR Services team was 93% higher than the 2018 average.”

How does this happen? Hackers perpetrate ransomware attacks by sending phishing emails that appear legitimate to unsuspecting employees, who then click on the emails and introduce the malware onto the organization’s systems. Ransomware may also be triggered by an employee’s visit to an infected website or to an advertisement containing malware injected into a legitimate website.

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Also in the spotlight are reports of crippling ransomware attacks perpetrated against local governments. The computer networks for the cities of Atlanta, Newark and San Diego (as well as major health care providers, the University of Calgary and others) were infected with SamSam ransomware. The FBI reports that the “toll of these cyberattacks was staggering: more than 230 entities infected, $6 million in ransom payments extorted,

and an estimated $30 billion in damages to the affected public and private institutions.”

Baltimore also suffered a ransomware attack on May 7, 2019, that led to the email accounts of city employees being shut down for nearly three weeks. The Baltimore Sun reported that “Baltimore’s budget office estimates a ransomware attack on city computers will cost at least $18.2 million – a combination of lost or delayed revenue and direct costs to restore systems.”

Cyber Extortion Coverage

them less by controlling premiums. When an organization gets hit with a ransomware attack, it should notify all of its liability and first-party insurers of the attack. The small demand could turn into a much larger demand at some point, which the insurer may refuse to pay based on late notice. If this happens, any premium savings that might have been achieved by withholding notice could be dwarfed by the non-covered loss. Notice to all relevant insurers is also important because coverage may also be provided under non-cyber liability policies such as liability, crime and property policies.

After all of this bad news, consider some good news: There is insurance for these risks. A best practice for companies and governments is to consider procuring a first-party cyber insurance policy that provides coverage for cyber extortion and ransomware events, as well as third-party coverage for liability to others arising from cyber events (such as liability to a customer the policyholder cannot serve because of a ransomware attack).

Avoid Sublimits If Possible. Certain insurance policies set a lower limit of coverage for cyber extortion and ransomware attacks. For example, a $10 million limit cyber policy may provide only $500,000 for cyber extortion. Insureds should consider whether a proposed sublimit amount is sufficient to cover a possible ransomware attack. Many insurers provide a full limit of liability for cyber extortion events, and the full policy limit might be offered without an additional premium.

Insureds must do their homework when purchasing a first-party cyber policy covering their out-of-pocket losses resulting from ransomware and other cyber intrusions, working alongside experienced brokers and cyber coverage counsel to carefully study the following extortion-related definitions, terms and conditions:

Deductibles Must Be Considered. A deductible for a ransomware event may be so high that your organization will be forced to pay a ransom demand from its own pocket. Insureds should consider how much financial responsibility is cost-effective to retain, and adjust the deductible to reflect this.

High-Level Considerations. A best practice for insureds is to purchase coverage for extortion demands and ransom payments, lost income resulting from the ransomware attack, extra expenses incurred to keep the business running, defense and indemnity for customer claims and other losses that could result from these events.

Cooperation Is Key. Cyber policies require insureds to cooperate with the insurer regarding coordination with relevant law enforcement and regulatory authorities.

Often, policies state that the insured may not disclose the existence of cyber coverage to the cybercriminals (or risk rescission of the policy), and that insureds must use expert incident response service providers and legal counsel selected and appointed by the insurer.

Definition of Extortion Should Be Broad. The definition of extortion defines the trigger for coverage of ransomware attacks. Insureds should understand the policy’s extortion definition and determine if they agree with the insurance company drafter’s characterization of the hazard. For example, an insurer may define extortion as involving an explicit threat to misuse or sell information. The insurer may deny coverage if the ransomware attack on your organization involves only a demand for money.

Secure Consent by the Insurer to Pay Ransom.

Extortion coverage very often requires insureds to seek and obtain written consent from the insurer before agreeing to pay the ransom. A slow insurer response may lead to delayed payments and increased monetary demands by the cyber thieves. Insureds put their extortion coverage at significant risk if they do not obtain their insurers’ prior written consent before paying a ransom.

Notice to the Insurer. Insureds should avoid making the assumption that a low ransom demand negates the need to provide notice of the attack to their insurers, or that strategic withholding of notice will ultimately cost

Consider Insurer Reputation. Insureds should consult with their cyber coverage counsel and cyber broker regarding the reputation of the insurers before buying cyber extortion coverage. Insurers’ track records for paying ransomware attack claims and other cyber breaches should be considered.

Getting the right cyber extortion policy is all about sweating the details. If the insured makes the correct buying decision, the pain and business disruption of a ransomware attack can be minimized. If it buys the wrong coverage, or has no coverage at all, they can be a costly distraction at best, and catastrophic at worst.

Carrie Marie Raver is a partner in Barnes & Thornburg’s Fort Wayne office. 260-425-4652 or carrie.raver@btlaw.com

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

Georgia Policyholders Required to Be Specific to Have Chance at Bad Faith Damages First Acceptance Insurance Company of Georgia, Inc. v.

Hughes, 826 S.E.2d 71 (Ga. 2019) Like most states, Georgia has a general rule that an insurer may be liable for an excess judgment entered against its policyholder if the insurer acted in bad faith in refusing to settle the claim within policy limits. The Georgia Supreme Court recently clarified the requirements for proving a negligent or bad faith failure-to-settle claim. The dispute stemmed from a motor vehicle accident caused by the policyholder that severely injured the underlying claimants.

The claimants’ attorney sent two letters to the insurer, one expressing an interest in settling the claims within policy limits, and the other requesting information about the policy within 30 days. Neither letter set a specific deadline for the carrier to respond to the claimants’ offer to settle.

The insurer did not respond to either letter, so the claimants sued the policyholder’s estate and won a $5.3 million judgment, which was well above policy limits. The policyholder’s estate countered that an insurer’s duty to settle did not turn on whether the claimant offered to settle, but rather on whether “the insurer knows or reasonably should know that settlement within the insured’s policy limits is possible.”

The Georgia Supreme Court agreed with the carrier, concluding that “an insurer’s duty to settle arises only when the injured party presents a valid offer to settle within the insured’s policy limits.” The question then became whether the claimants’ letters constituted “valid offers to settle.” The court ruled that the offer “was not a time-limited settlement demand,” and, thus, the insurance company “was not put on notice that its failure to accept the offer within any specific

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period would constitute a refusal of the offer.” Accordingly, it is now the rule in Georgia that it is the claimant’s or policyholder’s burden to make a clear, time-limited settlement demand in order to trigger the carrier’s duty to settle. In the absence of an explicit, time-sensitive demand, the insurer does not have a duty to settle, and the insurer cannot be held liable for bad faith.

This decision has been criticized by commentators as an overly narrow approach that places an unreasonable burden on policyholders. Historically, whether an insurer has a duty to settle has been a multifaceted question of fact, with the specific nuances of each case considered together to determine whether the carrier acted in bad faith. The insurer could not summarily snuff out the bad faith claim by ignoring the plaintiff’s explicit stated desire to settle a case at or within limits and contending that no clear settlement demand had been made. Now, in order to have a shot at bad faith damages in Georgia, the policyholder must choreograph settlement negotiations to ensure a record is made of an unconditional, time-limited demand by plaintiff. Carriers undoubtedly will cite this case to show that an adjuster is under no obligation to take any action in response to a settlement overture that does not constitute a formal offer susceptible to immediate acceptance, and may ignore demand letters unless they contain a specific deadline – something that previously might have been considered bad faith in Georgia, as it would be in many other states.

California High Court Holds That New York Choice-of-Law Provision, Barring Application of the Notice-Prejudice Rule Under a First-Party Policy, is Unenforceable Pitzer College v. Indian Harbor Insurance Company, 8 Cal.5th 93 (Cal. Supreme Court, August 29, 2019)

The California Supreme Court has handed down a groundbreaking decision for insurance policyholders, refusing to enforce a New York choice-of-law provision in a first-party policy that would have barred coverage for a claim the insurer contended had been submitted late.

The court held that the Notice-Prejudice Rule, which protects policyholders failing to report a claim within the policy’s reporting deadline unless the insurer can show the late notice caused it “substantial prejudice,” is a fundamental public policy of California. Because New York does not apply the rule to policies like this, the choice-oflaw provision would have eliminated coverage for the claim at issue had the law of that state been applied. California enforces such provisions only when the other state’s laws are not contrary to public policy. The Supreme Court ruled that the Notice-Prejudice Rule represents just such a policy, rendering New York law – and its rejection of the rule – inapplicable to this claim. The court also held that the Notice-Prejudice Rule applies to consent provisions requiring approval by the insurer to incur covered expenses.

In January 2011, Pitzer College discovered evidence of environmental contamination near a construction site on its Claremont, California, campus. It determined that immediate remediation had to be done for construction to continue, and completed this work by the end of April 2011. Pitzer gave notice of claim in July 2011 to its insurer, Indian Harbor, which denied coverage based on late notice and the insured’s failure to obtain its consent before incurring remediation expenses. The federal district court granted the carrier’s motion for summary judgment based on the policy’s New York choice-of-law provision, holding that the Notice-Prejudice Rule did not apply under the law of that state.

The Ninth Circuit certified to the California Supreme Court the questions of whether the Notice-Prejudice Rule is a fundamental rule of public policy affecting the enforceability of an out-of-state choice-of-law provision, and whether the rule applies to provisions in first-party insurance policies requiring the insured to obtain the insurer’s consent before incurring otherwise-covered expenses. The Supreme Court answered the first question “yes,” nullifying Indian Harbor’s New York choice-of-law provision, and therefore New York’s rejection of the NoticePrejudice Rule, as a defense to coverage for Pitzer’s claim.

The court was unable to answer the second question.

It held that while the rule applies to consent provisions under first-party policies, a third-party policy is subject to

a different analysis. The court observed that because a third-party insurer has a right to control the defense and settlement of a claim, a policyholder’s failure to obtain its consent to incur some expense could hamper performance of its coverage obligations. Pitzer and Indian Harbor disagreed over whether the policy at issue was first-party or third-party. As a result, the Supreme Court declined to decide whether the Notice-Prejudice Rule applied to the consent provision in the policy giving rise to Pitzer’s claim.

Insurance companies often add New York choice-oflaw provisions to their policies because they regard that state’s laws as more favorable than those of other states.

Regarding application of the Notice-Prejudice Rule to policies issued outside New York (such as Indian Harbor’s), this view certainly is justified. The Pitzer College decision establishes that in California, choice-of-law provisions in first-party policies that defeat the Rule are unenforceable.

This ruling, together with the court’s holding that consent provisions are also subject to the Notice-Prejudice Rule, are potent weapons for policyholders. California insureds now have the ability to resist the effect of out-of-state choiceof-law clauses which would relieve first-party carriers of the burden of proving prejudice before they can deny coverage based on late notice.

Connecticut Supreme Court Decides Major Coverage Issues Relating to Asbestos Litigation R.T. Vanderbilt Company, Inc. v. Hartford Accident & Indemnity Company, 2019 WL 4926802 (Conn. Supreme Court, October 8, 2019) On Oct. 8, 2019, the Connecticut Supreme Court issued a long-awaited decision on several important insurance coverage issues raised by long-tail liability asbestos claims under commercial general liability policies – and came out largely in favor of corporate policyholders.

R.T. Vanderbilt, sued by thousands of underlying plaintiffs alleging injuries from exposure to industrial talc containing asbestos that it mined and sold, sought coverage for these liabilities under multiple policy periods spanning 1948 to 2008. Following trial, the Appellate Court of Connecticut rendered what the Supreme Court called “an opinion of extraordinary complexity and comprehensiveness” that the high court upheld in all respects.

The Appellate Court had ruled that Vanderbilt was not responsible for costs during years it was uninsured, based

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on the “unavailability of coverage” exception to Connecticut’s pro rata “time on the risk” formula for allocating coverage for claims arising from continuous exposure to asbestos.

Under this rule, the policyholder is liable for a prorated share of indemnity and defense costs during the periods which it is uninsured or underinsured. The exception to this rule excuses the policyholder from paying its share of defense expenses, settlements and judgments during these periods if no insurance for such liabilities was available. The Supreme Court upheld the Appellate Court’s ruling that this exception applied here. Noting that there might be a different result if the policyholder kept making products containing asbestos after 1986 aware that such products were hazardous and uninsurable, the court nevertheless held that these facts were not present in this case.

The Supreme Court also affirmed the Appellate Court’s application of a “continuous trigger” for the underlying asbestos liability claims, holding that all policies in effect from a claimant’s date of first exposure to asbestos to the time of the claimant’s death are applicable. In addition, it adopted the Appellate Court’s conclusion that the pollution exclusions were intended to apply only to “traditional environmental pollution” and not to disease caused by exposure to asbestos.

In an issue of first impression, the Supreme Court affirmed the Appellate Court’s ruling that the occupational disease exclusions contained in certain excess policies applied not only to asbestos-related claims brought by Vanderbilt employees, but also to claims by non-employees “who contracted an occupational disease in the course of their work for other employers” as the result of exposure to talc manufactured by the company.

This decision is generally very favorable for insureds.

With the exception of its ruling concerning occupational disease exclusions, the Connecticut Supreme Court has come down solidly on the side of corporate policyholders seeking the broadest possible interpretation of coverage for asbestos liabilities.

Ninth Circuit Shuts Down Carrier’s Attempt to Expand California’s Prohibition on Coverage for Willful Wrongful Conduct First One Lending Corporation v. Hartford Casualty Insurance Company, 755 Fed. Appx. 710 (9th Cir. 2019) The U.S. Court of Appeals for the Ninth Circuit recently declined to broaden the reach of California’s Insurance Code Section 533, which prohibits an insurer from indemnifying policyholders for liability arising from the policyholder’s intentionally harmful conduct (e.g., fraud). The crux of the claim against the insured was that it engaged in illegal mortgage-lending practices by misrepresenting its affiliations with the claimant.

The complaint also included a claim for trademark infringement arising from the policyholder’s allegedly unauthorized use of the claimant’s slogan. On summary judgment, the carrier argued that Section 533 barred coverage for all claims, including the trademark infringement claim, since they ultimately sought “uninsurable restitution.” The U.S. District Court for the Central District of California agreed, emphasizing the public policy of making Lanham Act violations “unprofitable” to the infringing party. It also ruled that a policy exclusion for financial services claims independently barred coverage.

The Ninth Circuit, however, took a narrower approach and refused to find the claims so “’inseparably intertwined’ with willful conduct” as to render the entire action barred from coverage under Section 533. The court held that, despite the claim generally arising from allegedly intentional conduct, the claimant could have recovered on its trademark infringement claim without actually showing willful wrongful acts. It also held that the financial services exclusion did not apply to the trademark infringement claim. Accordingly, the carrier had a duty to defend the action.

This is a win for California policyholders in the face of numerous efforts by insurers to expand the scope of Section 533 and make it a catchall exclusion when there is no other way to avoid coverage.

Abby Vineyard is of counsel in the Atlanta office of Barnes & Thornburg. 404-264-4085 or abby.vineyard@btlaw.com

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