Denial of Coverage For Ponzi Claim Not Bad Faith

Posted on November 24, 2009 by Mike Aylward

A recent opinion of the U.S. Court of Appeals for the Third Circuit has emphasized the general rule that an insurer’s failure to follow its own internal procedures does not necessarily equate to bad faith.

In Smith v. Continental Cas. Co., No. 08-4140 (3rd Cir. October 8, 2009), Continental Casualty’s insureds were sued for marketing various securities in what later proved to be a Ponzi scheme. The insured tendered its claim to its professional liability insurer, Continental Casualty, which denied coverage. The insured thereafter entered into a settlement with the plaintiffs for $150,000 and an assignment of their rights against their insurer. The plaintiffs thereafter sued Continental Casualty for breach of contract and bad faith.
 

 

The Third Circuit affirmed the Pennsylvania District Court’s conclusion that the claims in question were subject to an exclusion in the Professional Liability policy for unapproved financial products, as was the case here.

Turning to the issue of the plaintiffs’ bad faith claims, the Third Circuit took note of the two-part test for recovery under 42 Pa. Const. Stat. § 8371. Thus, in order to recover, a bad faith claimant must establish by “clear and convincing” evidence that (1) the insurer lacked a reasonable basis for denying benefits and (2) that the insurer knew or recklessly disregarded its lack of reasonable basis. In this case, the court found that the plaintiff had evidence of neither prong. In light of the fact that Continental Casualty had prevailed on the contractual issue, it clearly had had a “reasonable basis” for denying coverage. Furthermore, there was no evidence that it had known or disregarded the lack of a reasonable basis for denial. Finally, although Continental Casualty’s internal best practice procedures apparently suggest that the insurer should communicate with the policyholder before denying coverage, the court observed that, “While perhaps Continental should have spoken with Sprecker before it made a final coverage decision, a failure to follow best practices does not give rise to a bad faith claim.”

The Third Circuit opinion also contains an interesting footnote with respect to the scope of the reasonable expectations doctrine in Pennsylvania. In this case, the court ruled that reasonable expectations doctrine “applies only to unsophisticated, non-commercial insureds, and only to protect such insureds from ‘policy terms not readily apparent and from insurer deception.’” In this case, the court found not only that the insureds were sophisticated but that in light of the clear application of this exclusion, any suggestion that they were entitled to coverage was not a reasonable one to hold.
 
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California Court of Appeal Again Upholds Absolute Pollution Exclusion

Posted on January 30, 2008 by Mike Aylward

After the California Supreme Court's 2003 opinion in MacKinnon, rejecting the application of an absolute pollution exclusion to injuries to building occupants by pesticide sprayings and declaring that such exclusions are limited to "injuries commonly thought of as "pollution" (ie. environmental pollution),  one might well have assumed that it would be a rare day indeed before a California court gave effect to such exclusions in bodily injury cases.  In surprising turn of events, however, the Court of Appeal has since done that in several recent cases.

The latest ruling to give an expansive interpretation to MacKinnon's construct of "environmental pollution" is the Second District's opinion this week in American Casualty Co. of Reading, PA v. Miller.  At issue were personal injuries suffered by a workman who, in the course of performing maintenance work in a sewer line, was exposed to methylene chloride that had been flushed into the sewer by Stripper Herk, a furniture stripping business (why don't the insureds in my cases ever have cool names like that).  Stripper Herk ultimately enter into a plea agreement with the U.S. Attorney in which it confessed to have discharged chemicals in violation of its permit. 

In the ensuing coverage litigation, the Los Angelese Superior Court ruled for CNA in 2006, holding that the worker's suit for injuries caused by exposure to the methylene chloride were clearly subject to the APE in a 2002 American Casualty policy as arising out of a discharge of pollutants on or from the insured's premises.  This finding was affirmed by the Second District of the Court of Appeal on January 29.

The court ruled that “an ordinary insured would reasonably expect that the release of methylene chloride into a public sewer is environmental pollution.”   In keeping with other recent opinions such as Ortega Rock Quarry and Garamendi v. Golden Eagle, the court held that the insured's discharge of methylene chloride into the sewer was a widespread dissemination of a pollutant into the environment.  The court rejected the insured's argument that such exclusions do not apply to "one-time, negligent" discharges or should be limited to "catastrophic events such as large scale industrial pollution   The court also held that the fact that the sewer in question was sealed merely limited the scope of injury and did not alter the fact that there had been a release into the environment.. Finally, the Second District held that the operator of a furniture stripping business should have been well aware of the need to handle such chemicals carefully.

Although not discussed in the opinion, the Second District's analysis is in keeping with the First District's opinion late last year in Cold  Creek Compost, Inc. v. State Farm Fire & Casualty Co., A114623 (Cal. App. November 20, 2007), in whichh the Court of Appeal ruled that neighbors’ nuisance claims due to exposure to offensive odors, dust and noise from the insured’s composting operations are subject to an absolute pollution exclusion. The First District declared that “the widespread dissemination of offensive and injurious odors from a commercial compost facility is ‘environmental pollution’ under MacKinnon and thus excluded from coverage...”

It will be interesting to see if the California Supreme Court takes an appeal from one of these cases.  Meanwhile, it appears that the rumors of the demise of the absolute pollution exclusion  in California were exaggerated after all.
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