National Insurance Law Forum

National Insurance Law Forum

Published By The Attorneys of the National Insurance Law Forum

CyberAttacks and Superstorm Sandy: Implications for the U.S. Power Grid

Posted in Property Insurance

Much has been written about business interruption losses following Superstorm Sandy and still more, of late, concerning the type of losses that might flow from a directed cyber-attack targeting U.S. infrastructure.  As yet, however, no one has looked at what happened after Superstorm Sandy and connected the dots to the implications it might have for future cyber-attacks.  That is until now.

Johns Hopkins has just published a monograph by Dr. Paul Stockton:  “Superstorm Sandy: Implications for Designing A Post-Cyber Attack Power Restoration System.”  The monograph discusses the remarkable speed with which electric power was restored in New Jersey and other Mid-Atlantic states post-Sandy and analyzes how the lessons learned as the result of Sandy might industry in planning against the risk of future cyber-attacks designed to bring down the power grid.

Stockton is a cyber-consultant in DC and one of the brighter guys in this growing field.  Before founding his own shop last year, he was the Assistant Secretary for Homeland Security at DoD and oversaw the Pentagon’s response to Sandy, Irene and other disasters.

American Law Institute Votes to Approve Restatement of Liability Insurance

Posted in Liability Coverage

Houston, we have an insurance Restatement.  Well, almost.

The American Law Institute voted at its annual meeting in Washington, D.C. yesterday  to approve Chapters One, Two and Three of the Restatement of the Law of Liability Insurance.  The final vote came at 5:42 p.m. after three hours of debate and nearly a dozen substantive motions by policyholder and insurer advocates.  As the meeting had already run past its scheduled ending time, the ALI did not reach a motion to restore “all sums” as the default allocation model in Section 44 that fifty leading policyholder counsel had signed.

The approved sections run the gamut of important principles of insurance law, ranging from policy interpretation, waiver and estoppel, misrepresentation, duty to defend, right to independent counsel, recoupment, duty to make reasonable settlement decisions, conditions, exclusions, coverage for punitive damages, excess/drop down and trigger of coverage.

The meeting got off to a confused start when the ALI began debate at 11:30 instead of the scheduled 2 p.m. with the result that several attendees were still en route from the airport.

Section 3:  A motion by Vanita Bank to restore the traditional “plain meaning rule” in place of the proposed “plain meaning presumption” was defeated despite comments by several judges that they foresaw the new rule causing confusion.

Section 12:  The Reporters were noncommittal about my concern that allowing insurers to be vicariously liable for the acts of defense counsel if the counsel is an insurer “employee” would inadvertently sweep within its ambit all staff counsel.  Tom Baker has agreed to review a paper that I will send him explaining the separation between staff counsel and claims operations.

Section 13(3):  Following last October’s Advisor’s meeting, the Reporters had eliminated their original language–which enumerated a few examples of situations where insurers could avoid a defense based one extrinsic facts where it was undisputed that they had not insured the claimant and the like–and adopted the California rule that a duty to defend can be avoided in all cases of undisputed facts.  Policyholders, led by John Buchanan moved to restore the old language, arguing that this gave to much discretion to non-lawyer claims handler.   The Reporters agreed to accept the motion without a vote and restored the old language.  They are adding a further exception for cases involving undisputed late notice under “claims made” forms.  At my request, they will also consider other possible exceptions where courts have permitted this (e.g. undisputed fact of insured’s criminal conviction for homeowner’s exclusions). consider other examples in October

Section 19: Despite policyholder objections, the Reporters declined to revisit the “failure to defend estops right to contest indemnity” rule that they dropped this Spring in favor of a rule of no estoppel if the insurer had a “reasonable basis” for failing to defend.  They stated, however, that might ultimately need to tweak Section 19 to reconcile it with their forthcoming analysis of bad faith issues in Chapter 4

Section 22: Bill Barker’s motion to permit recoupment defeated.

Section 24: Bob Cusumano’s motion to delete language holding insurers liable for excess judgments in any case where they fail to accept a reasonable offer of settlement was defeated after a spirited debate.  In response to the motion, Reporters had deleted language in Comment d. holding insurers liable even if the offer was at the “high end of the range of reasonableness.”  Insurer advocates argued that this did not go far enough and that the established rule was that insurer’s conduct should be evaluated based upon whether its conduct as a whole was reasonable.

Section 32:  Victor Schwartz’ motion to eliminate language in Section 32 adopting subjective intent as the default standard for expected or intended exclusions unless otherwise stated was defeated.  Victor’s motion had argued that the issue was far more nuanced than this simplistic rule would allow and that public policy disfavored creating coverage for intentional acts in most cases.

Section 33:    No motions but Reporters have confirmed that they will be revising their “trigger” discussion to set an end point of some sort to cut off a continuing trigger (e.g. loss in progress, post-manifestation, known loss).

Section 34:   As originally drafted, Section 34 would have required coverage for “aggravated fault’ (e.g. criminal acts, fines and penalties and punitive damages) unless expressly excluded.   the Tentative Draft issued last Spring revised it to state that if allowing such coverage conflicted with the public policy of a state, the insurer should still issue payment to the claimant but could sue its policyholder for reimbursement.  In the face of intense criticism and motions from Sheila Birnbaum and myself, the Reporters relented and have agreed to revise Section 34 to state that coverage is allowed “unless contrary to public policy.”  This will preserve the rule in most states that public policy forbids coverage, except in cases of vicarious liability.

Section 37:  This Section dealt with notice issues in “claims made” policies.  I had filed two motions, arguing that (1) the “notice-prejudice” rule did not apply to any notice requirement in “claims made,” not just the requirement that claims be reported during the policy period and (2) that language allowing insureds a “reasonable extra” time after the policy expired to report a claim would introduce uncertainty and engender more litigation in a market where additional time is almost always automatically available through 60 day ERPs.  The Reporters accepted these comments and have agreed to withdraw Section 37 for further consideration.

Section 38(3):  I originally filed a motion suggesting that the right to assign whole classes of claims should be limited to mergers but withdrew it upon receiving assurances from the Reporters that asset acquisitions did not create allow the acquiring entity to make claims “by operation of law” and must be accompanied by an express assignment of rights in the transaction.  This is consistent with the case law in most states.

Section 42:  The Reporters had adopted Zeig as the default rule unless excess policies expressly state that the underlying insurer had actually paid its policy limit as a condition to exhaustion.  Professor Stempel had moved to only give effect to such language if it had been specifically negotiated with the insured.  I and others pointed out that this was inconsistent with the general rule of policy interpretation in Section 3 and would create special treatment for the class of policyholders (directors and officers) probably least in need of special assistance.  The motion failed narrowly.

Section 43: No motions but Reporters urged to use wording other than “joint and several” liability to express their position.  Tort concept.

Meeting adjourned at 5:40 without taking up Section 44. Sections 37, 44 and 45 will be held over for consideration at the ALI’s next meeting along with Chapter 4 (bad faith, contribution actions

 

Washington Appellate Court Finds No Conflict of Interest for Law Firms that Represent Insurers and Defend Insurer’s Policyholders

Posted in News, Recent Cases

In a matter of first impression in Washington, the Washington Court of Appeals in a published decision, Arden v. Forsberg & Umlauf, et al., Washington Court of Appeals Division II, May 3, 2016, held a law firm with an insurer for a client may defend that insurer’s policyholder in an unrelated matter without creating a conflict of interest, or even disclosing that it also regularly represents the insurer in coverage matters.  The court held this as a matter of law.  The court also held a lawyer defending an insured under reservation of rights does not breach its fiduciary duties to its insured client or commit legal malpractice by (1) not persuading the insurer to accept the claimants’ first demand to the insureds; (2) not engaging in settlement discussions with the claimants until receiving the claimants’ written discovery responses, notwithstanding the insureds’ request for prompt resolution;  or (3) failing to consult with the insureds before rejecting the claimants’ first and second demands when there was no evidence the insureds were harmed by same.

Forsberg & Umlauf is a law firm in Seattle, Washington that represents insurers in coverage disputes and defends its insurance clients’ insureds in unrelated matters.  One of its insurance clients is Hartford, whom it represents in coverage matters.  In this case, a couple insured under a Hartford homeowners’ policy, the Ardens, shot and killed their neighbors’ puppy.  The neighbors sued the Ardens for willful conversion, malicious injury, intentional or reckless infliction of emotional distress, gross negligence and willful or reckless property damage.  The Ardens sought coverage under the liability portion of their homeowners’ policy with Hartford.  After initially denying a defense due to the policy’s intentional act exclusion, Hartford agreed to defend  the Ardens under a reservation of rights to deny coverage after the Ardens retained personal counsel, Jon Cushman, to assist them on coverage matters and monitor their defense.

When Hartford told Cushman it intended to use panel counsel (Forsberg) to defend the Ardens, Cushman said okay.  Forsberg sent the Ardens a letter explaining it was defending them in the suit against them and that it would not provide coverage advice to them or to Hartford.  The letter stated that, unless instructed otherwise, Forsberg would assume any settlement authority or instructions received from Hartford to settle were given with the Ardens’ consent and it would proceed accordingly.  (The Ardens and Cushman made it clear notwithstanding the reservation of rights that they expected all settlement monies to come from Hartford.)  Forsberg did not, in this letter or at any other time, tell the Ardens it represented Hartford in coverage matters.  Forsberg attorney Chris Gibson, assigned to the Ardens’ defense, met with the Ardens and explained they were his only clients and his goal was for Hartford to pay full indemnity for the suit against them despite the reservation of rights.

After Forsberg served discovery requests on the claimants but before they answered, the claimants made a timed settlement demand of $55,000 on the Ardens.  Cushman demanded Forsberg accept the demand and Hartford pay it.  Hartford declined because it needed documentation from the discovery responses regarding claimed damages and information about case value.  Forsberg explained to Cushman it wanted to wait until it had received claimants’ discovery responses, and requested and received an extension from the claimants.  Cushman did not at the time object to the extension.

After receiving the claimants’ discovery responses, Forsberg prepared a detailed litigation report and case evaluation and shared it with Cushman before sending it to Hartford.  It included a number, $35,000, Forsberg believed the case could be settled for.  It told Cushman it would allow the timed $55,000 demand to expire, then offer $18,000 with the goal of ultimately getting to $35,000.  Neither Cushman nor the Ardens objected.  The claimants then made another timed settlement demand, this time for $40,000.  Hartford told Cushman it would allow this demand to expire then counter at $25,000.  Cushman did not object to this offer at the time but later argued Hartford acted in bad faith by not accepting the $40,000 demand.  The claimants rejected the $25,000 offer, but the parties ultimately settled at mediation a few months later.  The only claims reserved were the Ardens’ claims for breach of fiduciary duty and legal negligence against Forsberg.  The trial court granted Forsberg’s summary judgment motion, dismissing all claims against it.  The Ardens appealed.

The Ardens argued Forsberg breached its fiduciary duty of loyalty to them by defending them under reservation of rights while Hartford was a firm client.  The appellate court dismissed this argument, holding as a matter of law that Forsberg’s representation of the Ardens while it also represented Hartford did not create a conflict of interest and that Forsberg had no obligation to even tell the Ardens Hartford was a firm client.

The Ardens also argued Forsberg breached its fiduciary duty of loyalty to them during settlement negotiations.  The appellate court disagreed.  The court held as a matter of law Forsberg owed no duty to the Ardens to persuade Hartford to accept the claimants’ initial $55,000 settlement demand, received while discovery responses were outstanding; that there was no evidence Forsberg breached a fiduciary duty regarding the Ardens’ interest in a swift resolution of the suit against them by seeking an extension to engage in settlement negotiations while waiting for discovery responses (especially when the Ardens and Cushman were adamant that Hartford wholly fund the settlement notwithstanding its reservation of rights);  that while a question of fact existed as to whether Forsberg breached its duty to consult the Ardens before rejecting the claimants’ first and second settlement demands, there was no evidence any breach injured the Ardens; and that even if Forsberg had a duty to consult the Ardens before making settlement offers, there was no evidence Forsberg breached that duty with respect to the first settlement offer, or that any breach regarding the second settlement offer injured the Ardens.

The appellate court upheld the trial court’s grant of summary judgment for Forsberg on both breach of fiduciary duty of loyalty and legal negligence.  The court stated a lawyer’s duties of loyalty and disclosure to its clients arise under the RPCs and Tank v. State Farm, 105 Wn.2d 381 (1986) and noted the parties’ experts disagreed about whether Forsberg’s longstanding representation of Hartford in coverage cases precluded it from defending a Hartford insured in a reservation of rights context.  Answering a question of first impression in Washington, the court held an attorney who represents an insurer in coverage cases is not automatically prohibited from representing that insurer’s insured when the insurer reserves its right to deny coverage.

The appellate court held under RPC 1.7 Hartford’s interests were not directly adverse to the Ardens with regard to Forsberg’s defense of them.  Hartford and the Ardens did have adverse interests with respect to coverage issues, but Forsberg made it clear it did not represent Hartford or the Ardens on those issues.   Moreover, the appellate court held an attorney who follows Tank protects herself against claims that a conflict of interest automatically arises under RPC 1.7 when she defends an insured under reservation of rights but also represents that insured’s insurer.  The appellate court also dismissed the Ardens’ attempt to follow California’s Cumis rule, pointing out that Tank, decided just two years after Cumis, specifically rejected Cumis by crafting its own set of rules for defense counsel.  So long as the specific Tank criteria are followed, an insurer-retained attorney does not violate her duty of loyalty to an insured.  The court held as a matter of law that Forsberg did not breach its fiduciary duty of loyalty by undertaking the reservation of rights defense of the Ardens.

The appellate court similarly dismissed the Ardens’ claim that Forsberg breached its fiduciary duty of loyalty by failing to give them notice of its long-standing relationship with Hartford and of potential conflicts of interest arising from Hartford’s reservation of rights, stating RPC 1.7 does not create an automatic conflict in this situation and Tank does not require the defense attorney disclose its relationship with the insurer defending under reservation of rights.  The fact that attorney Gibson specifically told the Ardens under Tank his obligations were solely to them and it was his practice to get the insurance company to pay everything, even in a reservation of rights situation and that the Ardens had their own personal counsel engaged in the reservation of rights process, further bolstered the court’s conclusion that there was no evidence Forsberg breached its duty to disclose a potential conflict of interest between Hartford and the Ardens.

The appellate court disagreed that Forsberg put Hartford’s interests above the Ardens’ during settlement negotiations by failing to consult with them before rejecting the claimants’ settlement demands and making counteroffers.  The court held a defense attorney has no obligation to persuade an insurer in a reservation of rights context to settle a case.  When coverage is disputed, an insurer’s decision necessarily involves an evaluation of the strength of its coverage defenses.  Imposing a duty on defense counsel to persuade an insurer to settle would require that attorney either to argue the insured’s position on coverage or advise the insurer on coverage issues, both of which would give rise to actual conflicts of interest.  Moreover, the Ardens had personal counsel who was in the best position to advocate for settlement with the insurer.  The court ruled a defense attorney’s duty is to give a fair evaluation of the liability and damages without regarding to coverage.

The appellate court acknowledged Forsberg did not expressly consult with the Ardens or Cushman before rejecting the claimants’ two settlement demands.  But Forsberg’s initial representation letter stated unless instructed otherwise it would assume any settlement authority or instructions from Hartford to settle are given with your [the Ardens’] consent; and the Ardens clearly stated they would not personally pay any part of a settlement and expected Hartford to pay it all.  Based on this competing evidence the court found a question of fact whether Forsberg breached its duty to consult with the Ardens, but pointed out an attorney can be liable for breach of fiduciary duty only if the breach caused some injury, and there was no evidence Forsberg’s breach harmed the Ardens.  (There was no evidence if Forsberg had consulted with the Ardens they would have funded the settlement themselves or negotiated a separate settlement with the claimants.)

The court ruled the same way on the Ardens’ argument that Forsberg was required to consult with them before making counteroffers.  With respect to the $18,000 counteroffer, Cushman expressly approved it.  And with respect to the $25,000 counteroffer, Cushman did not disagree with it or object to it after it was made.  Even if Forsberg breached some duty to consult with the Ardens, there was no evidence its breach harmed the Ardens.

Finally, the appellate court found no evidence Forsberg was negligent in making a judgment decision extending the time for settlement negotiations, despite the Ardens’ desire to settle promptly to minimize criminal charges arising from their shooting the claimants’ dog and to avoid exacerbating Mr. Arden’s PTSD and depression.  The court observed the Ardens’ predominant interest was for Hartford to fully fund any settlement.  Because at the time the first settlement demand came in Forsberg had not yet received the claimants’ responses to its written discovery so Hartford did not have the necessary information to evaluate the case, Forsberg was not negligent in delaying the beginning of settlement negotiations.

Upcoming ALI CLE

Posted in News

Please join me for an upcoming American Law Institute CLE (ALI CLE) program–Additional Insured Coverage: Avoid Liability and Indemnification Pitfalls. The program is broadcasting live on April 20, 2016 from 1:00 — 2:30 p.m. ET, as a webcast and telephone seminar. ALI CLE is extending a 50% discount to referrals registering for this course. Please contact me if you’re interested in attending; I’ll provide you with the coupon code to access the discount. I hope you enjoy the program!

Potential Uncertainty Regarding Liability Coverage for Bodily Injury and Property Damage Caused by Cyber Attacks

Posted in Liability Coverage, News

While liability insurance for cyber risks was initially created to address the risk of privacy breaches, evolving cyber threats pose risks of bodily injury and property damage that may test the scope of coverage under existing cyber liability insurance.

The traditional risk addressed by cyber liability insurance includes, for example, unauthorized access to a business’s electronically stored customer financial information.  A business that suffers a privacy breach may be exposed to liability for identify theft or fraud suffered by its customers.  New cyber threats seek to exploit the evolving ways that physical systems are becoming connected via the internet.  Examples you may have heard of include: the Internet of Things, Industrial Internet, Smart Cities, Smart Grid, or “Smart” Anything (e.g., cars, buildings, homes, manufacturing, hospitals, appliances).  See the National Institute of Standards and Technology homepage at http://www.nist.gov/cps/.

Each new avenue of interconnectivity simultaneously provides a new potential means of unauthorized access.  To illustrate, cyber threats may target:

Furthermore, the new types of unauthorized access no longer implicates only privacy breaches.  Cyber threats to interconnected “things” pose risks that include property damage and bodily injury.  It is not hard to imagine a malfunctioning car that may cause harm to person or property.

Furthermore, cyber attacks now also include threats to critical infrastructure facilities that pose even broader risks of harm.  For example, there have been documented cyber attacks that disabled oil pipeline leak-detection systems, gained control of the gas flow in pipelines, disabled water filtration systems in public water supplies, remotely derailed trains, pumped raw sewage into waterways as well as onto public and private property, manipulated facilities systems in hospitals, disabled electric grids and cut off electricity to an entire city, disabled nuclear power plant safety monitoring systems, and disabled critical airplane warning systems.  See Lucy L. Thomson, Cyber Physical Risks, ABA Litigation Section Insurance Coverage Litigation Committee, 7-12 (2016).

These new cyber threats pose apparently untested issues regarding coverage for bodily injury and property damage caused by cyber attacks.  Historically, typical CGL coverage and supplementary cyber coverage were intended to dovetail and to avoid providing overlapping coverage.  Thus, CGL coverage forms would cover bodily injury and property damage (but not injury to or loss of use of electronic data), while cyber coverage would typically exclude coverage for bodily injury and property damage.  See, e.g., Electronic Data Liability Coverage Form (CG 00 65).

In 2004, the ISO continued this trend by introducing Exclusion P for the CGL coverage form.  The new provision excluded “[d]amages arising out of the loss of, loss of use of, damage to, corruption of, inability to access, or inability to manipulate electronic data . . . used on . . . data processing devices or any other media which are used with electronically controlled equipment.”   The term “electronic data” was defined to include “information, facts, or programs.”   In certain circumstances, it might be argued that a cyber attack may disable, modify, or prevent operation of a computer program of computer code, and therefore may constitute “damage to . . . electronic data,” in which case, any resulting “property damage” or “bodily injury” might be excluded.  Of note, application of Exclusion P could depend on the mechanics of how the cyber attack is conducted (e.g., introducing new code as opposed to disabling existing code).

It appears that the issue of coverage for property damage or bodily harm resulting from a cyber attack has not been tested in reported court decisions, and it is unclear how the issue would be resolved.  Nonetheless, there remains a possibility that current cyber liability coverage might not cover bodily harm or property damage caused by cyber attacks.  For arguments from the policyholder’s perspective, see John Buchanan and Dustin Cho’s When Things Get Hacked: Coverage for Cyber-Physical Risks.  ABA Litigation Section Insurance Coverage Litigation Committee (2016).   The trend toward increasing internet connectivity of physical systems and the risks of resulting harm they pose will only make more relevant the issue of coverage for bodily injury and property damage caused by cyber attacks.

When Does The Statute of Limitations For An Insurer’s Failure to Settle Run?

Posted in Bad Faith/Extra Contractual

Although bad faith lawsuits against liability insurers for failing to settle within policy limits are all too common, there is significantly less case law addressing the issue of when such a cause of action accrues and, in particular, whether bad faith suits filed years after the fact may therefore be time-barred by applicable state statutes of limitation.       Such was the case in Connelly v. State Farm Mutual Automobile Ins. Co., No. 426, 2015 (Del. March 4, 2016),  a recent opinion issued by the Delaware Supreme Court.

Christina Connelly was rear-ended on October 12, 2007 by State Farm’s insured, Ronald Brown. At the time, Brown was insured under a State Farm policy with limits of $100,000/$300,000.  After the case went into suit, Brown offered to settle for $35,000.00 but State Farm insisted on taking the case to trial.  At trial, however, the jury entered an award of $224,271.00 along with interest and costs of nearly $110,000.00.  State Farm only paid its $100,000.00 policy limit plus interest for a total of $151,601.00 leaving half of the verdict unsatisfied.

After Connelly’s suit against State Farm as a judgment creditor and for bad faith was dismissed it was challenged by State Farm for lack of standing, Connelly obtained an assignment of Brown’s rights and proceeded forward.  In 2015, however, the Superior Court granted State Farm’s motion to dismiss, declaring that her action was untimely as the 3‑year statute of limitations under 10 Del. C. § 8106 had begun to run either on May 10, 2011 when Connelly made her settlement offer or on June 9, 2011 when State Farm had failed to accept it.  The Superior Court concluded that the statute of limitations had begun to run at the time of breach as that was when the insured was made aware of the possibility that her claims would be denied putting her on notice as to possible causes of action.

On appeal, however, the Delaware Supreme Court ruled that the statute of limitations against the liability insurer for failing to settle within policy limits accrues when the underlying judgment becomes final and non‑appealable and therefore reversed a lower court’s declaration that the plaintiff’s claim was time barred on the grounds that Delaware’s three year statute of limitations had begun to run as of the date of State Farm’s alleged breach of its duty to settle by rejecting an offer within limits.

Where There’s Smoke, There May Be Coverage: Marijuana Meets the Law

Posted in Property Insurance, Recent Cases

A provocative new opinion from Colorado (where else) has explored the potential scope of first-party property insurance coverage for a loss of marijuana plants. The opinion highlights some of the problems that first party insurers face in evaluating losses in an area that is emerging into the mainstream but has not yet entirely lost its lawless history.

In The Green Earth Wellness Center, LLC v. Atain Specialty Ins. Co., 13‑03452 (D. Colo. Fed. 17 2016), smoke and ash from a nearby fire overwhelmed the ventilation system for the insured’s retail medical marijuana growing facility in Colorado Springs, killing growing plants and contaminating product that was ready for sale.

The insured submitted a claim to its property insurer, arguing that the damaged plants were “stock” covered under the policy. The insurer responded that these were in fact, excluded “growing plants” and weren’t any that were subject to the “contraband” exclusion in the policy.

On cross-motions for summary judgment, Chief Judge Krieger distinguished between different classifications of marijuana plants including “mother plants”, “flower plants”, “veg plants” and “finished product.” In this case, the insured had sought $200,000 for damage to growing mother plants and clones as well as $40,000 for damage to buds and flowers that had already been harvested and were ready for sale.  While expressing some perplexity with respect to the notion that the mother plants and marijuana clones could be considered “stock”, the court found that the issue was uncertain.

On the other hand, while finding that the damaged marijuana was stock, Judge Krieger ruled that significant portion of the insured’s claim was excluded from coverage as involving “growing crops.”   Despite the insured’s argument that a “crop” necessarily meant something that was grown outdoors, the District Court held that the plain meaning of the exclusion applied to the marijuana mother plants, even though they were grown indoors in containers.  The court found affirmation of her analysis in extrinsic evidence of the drafting discussions between the parties which suggested that there was never an intention to cover the insured’s marijuana plants.  On the other hand, the court ruled that marijuana buds and seed that was ready to be sold was not subject to this exclusion.

The District Court also rejected the insured’s argument that denying coverage for this key aspect of its business enterprise would confound its “reasonable expectations” of coverage. In this case, the court found that the policy provided many different types of coverage apart from the risk of loss to growing plants and that eliminating coverage in this instance did not render the policy worthless.  The court also refused to eliminate coverage on the basis of a “contraband” exclusion in light of the conflicting policies of state and federal government concerning medical marijuana.

McCarran-Ferguson Not Implicated by Application of FAA to Policies Violating California Insurance Code §11658

Posted in Recent Cases

In Matter of Monarch Consulting, Inc. v National Union Fire Ins. Co. of Pittsburgh, PA, the New York Court of Appeals was asked to consider whether the McCarran-Ferguson Act—which precludes application of federal law in the face of state law regulating the business of insurance under certain circumstances—precluded application of the Federal Arbitration Act in the face of California Insurance Code §11658. The Court held that, because application of the FAA did not invalidate, impair or supersede §11658, McCarran-Ferguson was not implicated.

At issue was the enforceability of arbitration clauses in collateral agreements between National Union and its insureds in connection with the issuance of workers’ compensation policies. The collateral agreements, which extended credit to the insureds in return for the provision of collateral, required disputes arising under the collateral agreements be submitted to arbitration.

The insureds (and the California Insurance Commissioner as amicus curiae) argued that the collateral agreements and arbitration clauses were illegal and unenforceable under California Insurance Code §11658, which requires that insurers file workers’ compensation policies, endorsements and forms with the Workers Compensation Insurance Rating Bureau prior to issuing the policies, and also violated a California regulation requiring that collateral agreements be attached to and made part of such policies. The insureds further argued that compelling arbitration under the FAA in an unfiled insurance agreement would undermine the California filing statute, and, consequently, that McCarran-Ferguson reverse preempted the FAA, thus permitting the court to decline enforcement of the arbitration clauses. National Union conceded that the collateral agreements were not filed; however, it argued that McCarran-Ferguson did not reverse preempt the FAA, which would mandate arbitration, because application of the FAA would not interfere with California Insurance Code §11658.

The court agreed with National Union. Under the FAA, the court observed, an arbitration clause in a contract involved in interstate commerce is “valid, irrevocable, and enforceable, save upon such grounds as exist at law or in equity for the revocation of any contract” (9 USC §2), and the FAA preempts state laws requiring a judicial forum for resolution of claims. McCarran-Ferguson, on the other hand, was enacted to limit congressional preemption of state regulation of insurance. Under McCarran-Ferguson, “[n]o Act of Congress shall be construed to invalidate, impair, or supersede any law enacted by any State for the purpose of regulating the business of insurance … unless such Act specifically relates to the business of insurance” (15 USC §1012[b]).  Thus, in certain circumstances, explained the court, McCarran-Ferguson exempts state laws from FAA preemption.

Not so here. The court explained that McCarron-Ferguson would reverse preempt the FAA in this case only if: “(1) the [FAA] does not specifically relate to insurance; (2) the [California Insurance Code §11658] was enacted to regulate the business of insurance; and (3) the [FAA] would invalidate, impair, or supersede the [California Insurance Code §11658]. The court found the first two prongs of the test were satisfied; however, the third prong was not, because §11658 would not be invalidated by application of the FAA. The court reasoned that California Insurance Code §11658 does not “prohibit, limit, or regulate the use or form of arbitration clauses in insurance contracts,” because “although California Insurance Code §11658 may have required the filing of the [collateral agreements], the purpose of the filing rule is to ensure that the insurance documents comply with the Insurance Code and accompanying regulations—none of which pertained to the use or form of arbitration provisions.” Thus, “[n]either the goal of the statute nor its administrative scheme is undermined by applying the FAA.” The court also rejected the insureds’ argument that application of the FAA would undercut the California Insurance Department’s authority to review insurance agreements and would incentivize violations of the filing requirements, because the arbitrators would determine whether the collateral agreements and arbitration clauses are enforceable under California law despite the fact that they were not filed. The court further noted that the California Insurance Department could pursue an enforcement action against National Union, should it be so inclined.

The court also considered whether enforceability of the arbitration clauses was a question that should be resolved by the arbitrators or by the court. The collateral agreement provided that questions of arbitrability were to be determined by the arbiter.  The court held that this provision should be enforced as written, and, as a result, the question of whether National Union’s failure to file the collateral agreements rendered the arbitration clause unenforceable should be determined by the arbitrators.

“Claims Made” Coverage Is Alive and Well In New Jersey

Posted in Liability Coverage, Recent Cases

“Claims made” policies are alive and well in New Jersey. In 1985, the New Jersey Supreme Court was among the first in the country to rule that standard notice/prejudice rules did not apply to the requirement in “claims made” policies that insureds receive and report claims during the policy period.  Now the state Supreme Court has expanded on Zuckerman v. National Union, holding in Templo Fuente De Vida Corporation v. National Indian Fire Insurance Company of Pittsburgh, 2016 WL 529602 (N.J. Feb. 11, 2016) that a Directors and Officers insurer was likewise not require to establish prejudice to eliminate coverage based upon the insured’s failure to report claims “as soon as practicable.”

Classically, “claims made” policies limit coverage to claims received by the insured and reported to the insurer during the policy period (or some Extended Reporting Period).  These terms have been held to help define the scope of coverage and have generally therefore been held not subject to the “notice/prejudice” rule that most courts have adopted for notice conditions in liability policies.

In addition to these claims made and reporting features, “claims made” policies contain a notice condition that is also a feature in “occurrence”-based policies, namely that the insured must report claim that it receives “as soon as practicable.”  This feature is intended to allow the insurer to conduct a timely investigation rather than to define the scope of coverage.   Given its similarities to Condition 4(a) in the CGL form, should it be subject to the “notice/prejudice” that has generally been applied to these clauses in “occurrence”-based policies?

In fact, a few state supreme courts have recently distinguished these notice features of “claims made” policies from the claims made and reported requirements and have ruled that prejudice is required to eliminate coverage based upon the insured’s late notice of a claim. See, e.g. Prodigy Communications Corporation v. Agricultural Excess and Surplus Insurance Company, 288 S.W. 3d 374, 382 (Tex. 2009). Would New Jersey follow this lead?

In the Templo Fuente case, the insured (First Independent) was sued on February 21, 2006 for failing to obtain financing for a property deal.  On August 28, 2006, more than six months after being served with the first amended complaint, and after retaining counsel and filing an answer, First Independent provided notice of the claims to its D&O carrier, National Union. National Union denied coverage, asserting, among other defenses, that the claims against First Independent were made outside of the policy period, and that notice of the claims was not given to National Union as soon as practicable.

National Union’s D&O policy was issued on January 1, 2006 and remained in effect for a year. Accordingly, despite First Independent’s delay, the claim satisfied the policy’s requirement that claims be both received by the insured and reported to the insurer during the policy period.  However, the policy contained an additional requirement that notice of any claim be given “as soon as practicable.”

In ruling that there is no requirement of prejudice with respect to the notice obligations under a “claims made” policy, the court emphasized the difference between “claims made” and “occurrence”-based insurance as well as the difference in the size and sophistication of the entities that purchase “claims made” coverage compared to GL insureds.

The court rejected the insured’s effort to limit Zuckerman to issues involving disputes where the insured gives notice of a claim outside of the policy period as opposed to this case where the insured received a claim during the policy period but failed to give timely notice of it.

The court emphasized the fact that this was a director’s and officer’s policy and not a “contract of adhesion” and that, having been negotiated by sophisticated parties “the insurance company was not required to show that it suffered prejudice before disclaiming coverage on the basis of the insured’s failure to give timely notice of the claim.” As the court found:

“First Independent is not an individual and this policy is not a simple personal liability insurance policy. To the contrary, the insured was an incorporated business entity that engaged in complex financial transactions. During the initial application process for the Directors and Officers policy, First Independent listed itself as having at least fourteen full-time employees, two part-time employees, and a human resources department. The policy covered a broad variety of complex civil and criminal matters, including employment practices claims and security claims. In the procurement of a complex policy like this one, First Independent did not simply obtain a professional liability policy on its own; it sought out a broker, who procured the policy on First Independent s behalf.”

In ruling for National Union, the Supreme Court emphasized the different circumstances in this case than those governing most notice cases that it has ruled on in the past.  In most other cases, the court found that policy holders are unsophisticated consumers unaware of the requirements of coverage and that it would be unfair and unreasonable to give strict effect to policy provisions that might confound the insured’s reasonable expectations of coverage.  By contrast, in this case, the court found that the parties were sophisticated entities who had purchased insurance through sophisticated brokers and who should know and appreciate the requirements of coverage.  The court concluded, therefore, that it would “decline plaintiff’s invitation to read the insurance policy at issue as a contract of adhesion, or engage in a strained construction to support the imposition of liability or write a better policy for the insured than the one purchased.”

Boston College Law School Initiates Scholarship Colloquium

Posted in News

A few weeks ago, I co-chaired a symposium on the New Face of Insurance at the Boston College Law School.   The program was organized by the American College of Coverage and Extra-Contractual Counsel and presented in conjunction with the law school’s insurance studies program.

Hot on the heels of that successful symposium, BC Law has announced a writing workshop for new voices in insurance law, to be called the 2016 Liberty Mutual New Scholars Workshop on Insurance Law and Risk  (in recognition of the crucial financial support that Liberty Mutual generously gave to BC a few years ago to found a chair of insurance law).

The Liberty Mutual workshop is open to practicing lawyers and to law faculty with less than six years of teaching experience.  The law school is inviting scholarly submissions exploring topics in insurance law or risk, including but not limited to—

  • Interpretation of insurance contracts;
  • Solvency regulation of insurers;
  • Market conduct regulation of insurers;
  • Systemic risk regulation of insurance;
  • Holding company oversight of insurance groups;
  • Issues in cross-border insurance regulation and comparative insurance law;
  • Emerging issues in specific lines of insurance, including but not limited to health insurance, catastrophe insurance, property and casualty insurance, and life insurance; and
  • Alternative risk transfer mechanisms.

The Law School has also announced plans for a June 9, 2016 symposium at its Newton Centre campus where authors will present their papers.

Lawyers wishing to submit papers for this workshop should send a full paper of précis of 88-1200 words no later than March 21.    Only unpublished papers will be considered, although papers may be posted on SSRN, bepress, or as part of a similar working paper series. Authors must commit to participating in the full day-long workshop in Newton on June 9, 2016.   Submissions and inquiries should be directed to Professor Patricia McCoy at   patricia.mccoy@bc.edu