California Insurance Law Observer : Commentary on Legal Claims: Liability Counseling: Insight into Malpractice and Portfolio Audits: Discussions on Fiduciary Liability

A key element to proving a bad faith claim is the evidence of loss.  If a policyholder has to sue an insurer to obtain coverage on a claim, that part should be an easy proof, once coverage is established.  After all at the very least, the policyholder incurred the attorney fees and costs of suing for the insurance benefits, which amount to recoverable Brandt fees.  Where the Court determines the coverage issue in favor of the policyholder in a pretrial adjudication so that the policyholder wins the coverage fight, then the case is well poised for a jury to determine the remaining bad faith and related tort damages claims, including potential punitive damages. 

If the insurer wakes up and pays the contract claim plus interest, would that insulate the insurer from the rest of the claims?  Sometimes yes, as demonstrated in the recent Ninth Circuit decision, R & R Sails, Inc. v. Insurance Company of the State of Pennsylvania, 2012 DJAR 3755 decided on 3/21/12.  Practice pointer to insurer’s counsel: Pay that claim with interest when the Court finds the claim covered!

So how could the court in R & R Sails throw out the bad faith claims?  The policyholder’s counsel made the mistake of failing to provide either a detailed description or, better yet, actual copies, of the invoices despite the insurer’s rather late but nevertheless, repeated requests for them. Practice pointer to policyholder counsel: It is imperative that at least redacted copies of invoices be provided to the insurer at the very latest when exchanging the trial exhibits. 

Remarkably, R & R Sails’ counsel failed to do so and the District Court issued a preclusion sanction under F.R.Civ.P., Rule 37(c)(1) which led to the dismissal of the bad faith claims and an award of costs to the defalcating insurer!  Talk about snatching defeat from the jaws of victory!

While the Ninth Circuit took pity and reversed the dismissal and related cost award to remand for further proceedings, those proceedings will be limited to a hearing to determine if the policyholder’s counsel’s failure to provide the invoices “involved willfulness, fault or bad faith” to meet the required findings in order to impose the “harsh” remedy of dismissal, a formality not yet undertaken by the trial court.  Nimble insurer counsel avoided disaster, while the policyholder counsel fell short of the mark.  Never take your eye off the ball, even where you appear to be winning!

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As I have done for the last twenty years, I attended the Mid-Year meeting of the Insurance Coverage Litigation Committee of the Tort and Insurance Practice Section of the American Bar Association held in Phoenix, Arizona.  The three days of seminars were intense and covered a wide range of topics, including:

• Coverage issues arising under CGL;
• Media Liability and D & O; and
• Other professional liability policies.

The kinds of insurable losses discussed ran from construction defect, to cyber crimes to financial losses related to “liars loans” or fraudulent mortgages.  I even heard from a U.S. Attorney prosecuting criminal mortgage related cons and the FBI on cyber crimes.  Insurance coverage for construction defect cases, though a more mundane subject, was a topic I found particularly interesting.

Among the arcane issues discussed was whether construction defects are actually “occurrences” at all.  And if so, whether each defect is an occurrence so as to make multiple deductibles applicable, thus, diminishing the value of applicable insurance policies.  Several cases out of New Jersey addressed the issue of whether faulty workmanship is a fortuity constituting an accident, and thus an occurrence, and came to surprising conclusions.  Generally if the faulty work damaged other property, it was considered an occurrence and the resulting property damage was covered, but a recent case Penn. Nat’l Mut. Cas. Ins. Co. v. Parkshore Dev’t Corp. 2008 WL 4276917 (D. N. J.) re-examined the issue.  Several earlier cases found such claims not an accident thus not an occurrence. e.g., Fireman’s Fund Ins. Co. v. National Union 387 NJ Super. 434 (app. Div 2006).  Yet if the faulty workmanship caused damage to property other than the work done by the insured, there was an occurrence.  S.N. Golden Estates v. Continental Casualty 293 NJ Super. 295 (app. Div. 2006).  Yet the Parkshore court found a subcontractor’s faulty work part of the work of the general contractor Parkshore, so the court concluded that there was no occurrence, meaning no coverage.

A later case confirmed this unfortunate trend in New Jersey limiting coverage for construction defect claims.  Penn. General Ins. Co. v. Menk Corp.  2011 WL 5864109 (D. N.J.) In the Menk case the insurer argued there was no coverage for the faulty workmanship of the insured.  The insured argued there were claims of damage to third parties’ property, thus there should be coverage.  Unfortunately the court did not agree with the insured, and applied the Parkshore holding to find no occurrence and thus, no coverage for faulty workmanship claims.  Iowa and Missouri decisions were in accord.  Other states like Arkansas, and California tended to exclude coverage for damage to the work of the insured, but provide coverage for resulting damage to other property, that is, “other than to the work product itself."

Insurers are ever imaginative in coming up with new arguments, but you will never see insurers arguing for multiple occurrences where that would create endless limits.  Rather, these arguments emerge where the effect would reduce the liability by multiple deductibles.  Insurers have long since standardized the practice of limiting the number of policy limits to no more than two occurrences, the so-called aggregate limits recited on every declarations page of a liability policy.  Thus, where deductibles are also listed (and especially if they are sizable), insurers are likely to argue that more than one occurrence took place, in order to multiply the number of deductibles.  This discussion in the construction defect circumstance also comes up in professional liability policies issued to architects and engineers.

All the myriad ways to avoid or limit coverage in professional liability policies are addressed in case law throughout the country and often come into play in the architect/engineer policies.  These include:

• Claims that the notices were not timely (no coverage);
• The claims related to earlier notices, so only those already impaired earlier policies are at risk (limited coverage);
• Contentions that there were multiple claims (so, multiple deductibles—limiting available coverage ) –this one only if there are large deductibles and stated aggregate limits—;
• Otherwise, the claims would meet the standard argument that several insurance claims are inter-related and thus despite that there being multiple claims, there is only really one claim, even if the claims were reported to several policies (i.e., just one limit available).

As always these seminars provide insight into the latest case law, new trends in the case law and best of all, leads to where the insurers are focusing their sights in the battle for insurance coverage.

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Ever since my late client Dean Lesher insisted that we tender the defense of a straightforward antitrust case to his CGL insurance carrier -- a decision which ultimately won him a decisive jury verdict in Travelers Ins. Co. v. Lesher (1986) 187 Cal. App. 3d 169 -- I have always reviewed insurance policies for my antitrust clients in the hope of finding coverage language which might allow the tender of such formidable litigation to the insurers, but  never found  much to lend me hope.  I was thus very interested in a recent case where coverage was sought, but denied, in a false advertising case because of an "antitrust exclusion."  The case was decided by the First Circuit under Massachusetts law; but it is a rare bird and deserves this comment.

The case is Welch Foods, Inc. v. National Union Fire Ins. Co. (2011) 659 F. 3d 191; but the short per curiam opinion relies almost wholly on the District Court's decision granting the insurer's motion for summary judgment, which is not much deeper in its analysis.  It can be found at 2010 WL 3928704.  The complaint alleged that a competitor and a consumer class had accused Welch of engaging in "false and misleading advertising" and "false advertising and deceptive labeling" in advertising its pomegranate juice.  Welch sought insurance coverage under the advertising coverage provisions of its insurance policy, on the ground that "Welch's statements that its product contained 'pomegranate juice' (if in reality, the juice was primarily comprised of apple and white grape juice) could be deemed to be 'misleading statement[s]' and thus fall within the ambit of the policy."

The opinions do not state the nature of the policy under which Welch sought coverage; but it was likely a D&O.  The District Court denied coverage because of a policy provision that was captioned "Antitrust Exclusion," which excluded coverage for claims "alleging, arising out of, based upon or attributable to, or in any way involving either directly or indirectly, antitrust violations, price fixing, price discriminations, unfair competition, deceptive trade practices and/or monopolies, including actions, proceedings, claims or investigations related thereto ...."  I had not previously seen this exclusion.

The District Court denied coverage, reading the exclusion broadly:  "[T]he plain language of the exclusion is broad enough to include a variety of anti-competitive behavior. Nothing in the text of the exclusion limits it solely to antitrust claims. "  I can't quarrel with the court's grammatical analysis:  "deceptive trade practices," taken literally, would be something that happened in business or commerce  ("trade practices") and that is deceptive, i.e., "apt or tending to deceive."  That would cover virtually all business torts, and make much of the "personal injury" coverage illusive, especially the advertising coverage.

But there is another approach to this issue:  the rule of noscitur a sociis, or "a word is known by the company it keeps."  If so read, the exclusion for unfair trade practices would be considered in the well established context of that phrase in the antitrust world.  Section 5 of the Federal Trade Commission Act, known widely as the "little Sherman Act,"  is generally thought of as the fountainhead of "unfair business practices" in the antitrust context.  It prohibits "unfair methods of competition in or affecting commerce, and unfair or deceptive acts or practices in or affecting commerce."  It seems fair to say that a knowledgeable lawyer, reading the "antitrust exclusion" of this insurance policy, would think that it addresses "trade practices which conflict with the basic policies of the Sherman and Clayton Acts," as the  Supreme Court held in FTC v. Brown Shoe Co. (1966) 384 U.S. 316, and would think that the insurer must defend other commercial cases which assert improper advertising and the like.

Indeed, in California the courts have at times required that exclusionary clauses be read in their context, perhaps most prominently in MacKinnon v. Truck Ins. Exchange (2003) 31 Cal. 4th 635, where the court stated that "[a]lthough examination of various dictionary definitions of a word will no doubt be useful, such examination does not necessarily yield the 'ordinary and popular' sense of the word if it disregards the policy's context. [Citation].  Rather, a court properly refusing to make "'a fortress out of the dictionary,''" [citation] quoting Justice Learned Hand's dictum in Cabell v. Markham (2d Cir.1945) 148 F.2d 737, 739) must attempt to put itself in the position of a layperson and understand how he or she might reasonably interpret the exclusionary language."  By that reasoning, the California Supreme Court read the absolute pollution exclusion, now virtually universal in liability insurance policies, to apply only to the conduct which led to this exclusion, i.e.,to conduct "commonly thought of as pollution, and not to a landlord's negligent use of ordinary pesticides (p. 655).

I have mixed feelings about having an insurer defend an antitrust case for the insured.  But the reasoning of the Welch case seems dangerous, and mistaken to boot.   I would like to think that in California, the outcome would have been different.

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Last March, Joan Cotkin wrote a blog post entitled, "When an Insurer Fails to defend -- They Must Pay the Bill in Full."  She pointed to a then 17-year old case which had held that an insurer that wrongfully fails to defend a claim may not later challenge the privately retained counsel's defense strategies and noted that the same insurer had just lost a very similar case.  Insurers, Joan said, "are slow learners."

It's not necessarily that they are slow learners.  Perhaps, they simply prefer to ignore what the courts have taught them and hope that they can bamboozle a judge somewhere or exhaust their insured's staying power.  Another case that presented a variant of the case Joan wrote about in her March post has just shown that insurers will try and try again, and that policyholders must remain patient and vigilant.

In Janopaul + Block Companies, LLC v. Superior Court, ___ Cal. App. 4th ___, published November 17, 2011, the insured was sued along with others for construction defects and timely tendered defense of the suit to its insurer, St.Paul Fire & Marine Insurance Company.  St.Paul acknowledged receipt of the tender, asked for extensive information from its insured and received that information, and then failed to act on the tender for two years!  It then accepted the tender under a reservation of rights and confirmed that the insured should defend through its own "Cumis" counsel and cautioned the insured that it would not pay for cross-complaints which were necessary because multiple parties had been involved in the construction.  But another year elapsed before St.Paul acknowledged the insured's bills for attorneys' fees, which it then promptly disapproved for various technical reasons, such as block billing etc.  St. Paul invited arbitration of the now more than 3 year old fee dispute, and when the insured refused, brought this action to compel arbitration under the Cumis statute, Cal. Civil Code section 2860(b).  the trial court granted the petition although the insured had meanwhile filed a bad faith action against St.Paul, claiming unreasonable delay in accepting the tender  and in paying the fees.

The court of appeal issued a writ of prohibition, directing the trial court to hear the bad faith case before possibly referring the matter to arbitration, depending on whether the insured could sustain their claim of bad faith.  If St.Paul had a duty to defend and breached that duty without valid reason, it would be guilty of bad faith, and the unpaid attorneys fees would be resolved as part of the insured's damages for that bad faith conduct.

But curiously, the court gave St.Paul a lifeline, stating in a final footnote that it was "not deciding in this proceeding whether the delay by St.Paul in accepting the tender of defense and reserving its rights constituted a breach of duty/bad faith."   If it was ultimately decide that this was not a breach, St. Paul could then still go to arbitration.  Wouldn't you think that 2 years of the insurer's massaging a tender without response is bad faith in and of itself?  What is the insured to do while the suit is pending and the insurer fiddles?  There are plenty of cases that hold that an unreasonable delay in accepting a tender is a breach of the insurer's duty.  For instance, just a year ago another California court ruled in Intergulf Development Corporation v. Superior Court (2010) 183 Cal. App. 4th 16, that where the insured had  demanded coverage, rejected panel counsel, retained its own counsel and then sued for bad faith, recovery of attorneys fees etc., the dispute could not go to arbitration.  It held that the gravamen of the complaint was the insurer's failure to defend and breach of contract, where the cost of defense would be the measure of damages. 

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We have noticed a more aggressive trend of liability insurers filing reimbursement actions after settling claims against their insureds.  What about an excess insurer who seeks back its settlement payment where the underlying insurer does not go along with the reimbursement effort?  Seems unlikely and in any case these are rare claims for a reason.

An excess insurer may argue that its policy, even as a following form excess, is an independent contract and it is entitled to interpret the same differently from the underlying insurer.  Generally that argument will not fly in California based on the holding of the court in Diamond Heights Homeowners Assoc. v. National American Ins. Co. 227 Cal App 3d 563, 580 (1991), which held “we conclude a primary insurer may negotiate a good faith settlement of a claim in an amount which invades excess coverage, and that the primary insurer may enter into such settlement binding upon the excess insurer without the excess insurers’ consent.”  Indeed, under the “following form” doctrine, the Courts have held that “disparate risk allocation between primary and excess carriers in inconsistent with the followed form [doctrine]” Coca Cola Bottling Co. v. Columbia Casualty 11 Cal App 4th 1176, 1182 (1992).

Can an insurer base its reimbursement claim on the fact that the settlement included consideration paid to its insured on a cross-claim?  Not likely.  Under the rather ancient case of Jess v. Herrmann 26 Cal. 3d 131, 143 (1979) the California Supreme Court held that a set off which would reduce the insurer’s payment obligation to the claimant by the value of the insured’s claims against the claimant would “provide an inequitable windfall to an insurance carrier at the expense of the carrier’s insured.”

It is a rare case indeed, where a reimbursement action will succeed if there were potentially covered claims requiring a defense, as the burden of proof will be on the insurer to show what part of the amount paid was not covered.  This is because generally speaking an insurer must not consider coverage issues when funding a settlement according to the even older California Supreme Court case of Johansen v. Calif. State Auto Ass. 15 Cal 3d 9 (1975).  Insurers may reserve the right of reimbursement and in order to pursue a reimbursement action, must do so, as it is a quasi-contractual right.  Blue Ridge Ins. Co. v. Jacobsen 25 Cal 4th 489, 503 (2001).

However, only in those instances where an insurer can demonstrate some portion of a settlement was made larger and was solely allocable to uncovered claims, may it seek reimbursement according to the “larger settlement rule” in California.  Nordstrom, Inc. v. Chubb & Son Inc. (9th Cir. 1995) 54 F 3d 1424.  It is even harder where the insurer seeks reimbursement of defense costs.  The Insurer bears the burden of proving, by a preponderance of the evidence, the defense costs solely allocable to claims not potentially covered according to Buss v. Superior Court 16 Cal 4th 35, 53 (1997).  That some portion of the defense costs benefit uncovered persons or uncovered claims does not make them reimbursable, and some courts have questioned whether an insurer can ever prove allocation of defense costs. State of California v. Pacific Indemnity 63 Cal App 4th 1535, at 1548 (1998).  Good thing, because cases which spawn other cases can make litigation endless and actually, are disfavored by the courts for that reason.

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A binder is a handy device in the insurance business.  In fact, it is often essential.

A binder is a short memo, almost always from the insurance agent or broker, confirming that a specific policy has been bound by a specific insurance company, for specified risks and time, and in stated dollar amounts.  Since it usually takes an insurance company quite a while after it has agreed to insure a particular risk to issue its written policy, which may be 30 or 50 pages long, the binder is often the only evidence – and clear evidence – of the parties’ contract.  For it may be many months before the carrier actually sends out the policy, and in the meantime, accidents may happen!

Courts have wrestled with the effectiveness and meaning of binders when an occurrence or other event that might trigger a policy takes place after the insured period begins but before the policy is issued.  I have written elsewhere (“The Emperor Wears No Clothes: Why Is an Insurance Policy the Contract of the Parties?" Insurance Coverage, May/June 1998) that the insurance policy is not the agreement of the parties – after all, the policyholder never agrees to it or countersigns it – but only a confirmation of certain insuring commitments to which the insurer has decided to commit itself in writing.

California’s Legislature has also weighed in.  Insurance Code § 382.5, adopted in 1989, holds that a binder must be in writing.  It then is good for 90 days unless otherwise stated, and “shall be deemed to include all of the usual terms of the policy as to which the binder was given,” including specified endorsements.

Oregon has a much more liberal law about binders.  Oregon Revised Statutes § 742.043 provides in part:

(1) Binders or other contracts for temporary insurance may be made orally or in writing, and shall be deemed to include all the usual terms of the policy as to which the binder was given together with such applicable indorsements as are designated in the binder, except as superseded by the clear and express terms of the binder.

That part is very much like the California statute; but the section continues:

(2) Except as provided in subsection (3) of this section and ORS 746.195, within 90 days after issue of a binder a policy shall be issued in lieu thereof, including within its terms the identical insurance bound under the binder and the premium therefor.

Further subsections allow for extensions of the binder and note that this section does not apply to health and life insurance, as the California statute also provides.

In a recent Oregon Supreme Court case, Stuart v. Pittman, 350 O.R. 410, 255 P.3d 482 (2011), the insured had made an oral binder with the insurer’s agent.  The insured told the agent that he was building a new home and wanted “coverage from the start of construction to its finish and coverage beyond what normally would be covered in a homeowners’ policy” – “In all instances that something goes wrong during construction.”  The agent orally assured the owner that the coverage was in place, and construction began.

The construction site soon suffered major storm damage.  The agent confirmed that coverage was in place “and that mold damage also might be covered.”  No policy had been sent yet.  But when the policy later arrived, it excluded a number of perils, including those that had meanwhile actually occurred.  The insurer denied coverage.

A jury awarded the insured damages for the covered loss.  The intermediate appellate court reversed, but the Supreme Court ultimately affirmed the verdict.  It held that since the insured had made plain to the agent that he wanted all risks coverage and since the agent had confirmed that this was the covered risk, those terms were clear, as the jury had also found.  Even though the actual written policy varied greatly from the insurance the broker had bound, it was the binder (indeed, only an oral binder) that controlled, not the insurer’s after-the-fact version of coverage which excluded the risks that had by then actually taken place.

The Oregon statute makes good sense.  The most recent California case on binders, without the benefit of that broad statute, also upheld the insurer’s commitment as expressed in a specifically authorized binder, Chicago Title Ins. Co. v. AMZ Ins. Services, Inc. (2010) 188 Cal.App.4th 401, though in that case there was no issue about the policy deviating from the coverage the binder had promised.

Though California cases should follow the binder’s commitments where the policy fails to follow the binder, our State still would benefit from  a statute like Oregon’s, so that when an insurance policy “with all the usual conditions,” or as otherwise specified, is bound, the insured will have certainty that the committed coverage will actually be in place when it is needed.

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We all need a piece of good news in the midst of the financial markets' gloom.

It should therefore be welcome information that the California Insurance Commissioner,
Dave Jones, issued a press release today that puts Standard & Poor's downgrade of "certain insurers" credit ratings into context.

S&P downgraded many insurance companies' credit ratings from AAA to AA++, just as it did
to U S Government securities and for the same reason: because the insurers had "significant
investments" in U S securities, and S&P thought that their ratings should not be higher than
those whose securities they had invested in.

But, said Commissioner Jones, the rating actions have no impact on the actual holdings of such
securities by insurance companies and thus have "no impact on insurers' financial reporting of
risk-based capital and asset valuation reserves."  Thus, and most meaningful for policyholders
who look to their insurers to hold them harmless of covered claims, the downgrade "has no impact
on insurers' claims paying abilities."

Commissioner Jones got it right.  The assets held by insurance companies as part of their reserves for payment of claims are no less sound because of the downgrades; and the California Insurance Commissioner, like his counterparts in other states, is charged with diligent oversight of those reserves and of the assets which make them up.  The Commissioner has promised that his department "will  continue  to exercise strong financial oversight and carefully monitor the financial condition of insurers." That is reassuring news at a time when it seems that the markets are reacting to panic and rumor.

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I have maintained for many years that an insurance policy is not the agreement of the parties, but only the insurance company’s confirmation of the covenants it expects to fulfill under the parties’ contract.  The insurance agreement is made when the insured, often through its agent the insurance broker, asks the insurer to underwrite a certain risk or risks and the insurer agrees to do so for a stated price, which the insured accepts and pays.  The policy itself, which the insured never sees until it arrives in the mail – often months after the policy period has incepted, or begun – is a form that the insurer takes off its shelves, perhaps from a choice of forms it maintains, and to which it then adds various riders.  There is no countersignature by the insured, and the contract has long been in force when this document arrives at the insured’s address.  Why is all the fine print in that product, which is often many dozens of pages long, the “agreement between the parties?"  I wrote an article on that subject 13 years ago, “The Emperor Wears No Clothes:  Why Is the Insurance Policy the Contract of the Parties?” (Coverage, Spring/Summer 1998 issue).

Now there is a new case which shows how much my reasoning is needed.  In Mission Viejo Emergency Medical Associates v. Beta Healthcare Group (2011) ___ Cal. App. 4th ___; 2011 DJDAR 11303, a physicians’ group sued its insurer, Beta, for bad faith in the defense of a malpractice claim; and Beta responded by a demand for arbitration, pointing to an arbitration clause in the policy.  The trial court denied arbitration because there had been no reference to arbitration of disputes in the application form Beta had asked the physicians’ group to complete, which the doctors naively thought would define the insurance provisions they were being promised.

But the court of appeal reversed and ordered the dispute to arbitration, purely because the policy, when finally delivered to the Mission Viejo physicians, contained an arbitration clause.  This, the court held, was the parties’ contract – although there is not a word in the opinion to the effect that the doctors ever knowingly agreed to this provision or even knew it was there!  When you buy a shrink-wrapped high tech disc, the wrapping often contains a contract of sorts, which you accept by stripping it from the package; but here the “contract” terms were unilaterally put forth by the insurer and for all the opinion states, never even seen or read by anyone at its receiving end – and where, if normal circumstances prevailed, the policy was likely delivered long after the term of coverage had begun.

I thought that I had remembered language in the Insurance Code to the effect that the policy was the parties’ contract; but I am happy to find that apparently is not the case.  Rather, Section 380 of that code states: “the written instrument, in which a contract of insurance is set forth, is the policy.”  To me, that means only that the policy is the insurer’s written confirmation of terms of the contract; but the contract – to which the insured must have agreed, as I mentioned at the outset – is whatever the agreement was.  Often, but not necessarily, that agreement is expressed in the binder.

So, what does this mean?  I think that in cases such as Mission Viejo, the insured should be able to assert that self-serving language in an insurance policy which lies outside the parties’ understanding at the time they contracted, should have no standing and should not be enforced by the courts.

And we can go beyond that, though not all at once:  If the policy is not – or not necessarily – the actual agreement of the parties, then the door should be open to argue about other clauses that the carrier may have slipped into the half pound of paper it sends in the mail after the policy has incepted.  To be sure, one wouldn’t want to do that in every case, because that would become expensive and wearing, and good coverage arguments might also be available from the policy language as such.  But once the idea gets a foothold – and I think that as a general proposition it is certainly correct and should prevail – then the possibilities of greater fairness and justice in coverage disputes become very tempting indeed.

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On July 13, 2011, the Second Appellate District, Division Seven published an opinion authored by Justice Zelon which appears to turn the clock back on the pivotal decision which rocked the world of insurance coverage, Gray v. Zurich Ins. Co. (1966) 65 C. 2d 263.  In the Gray v. Zurich case, the California Supreme Court found that Zurich had an obligation to defend Dr. Gray notwithstanding that he was sued for assault and battery.  Zurich’s “comprehensive personal liability” policy promised “to pay on behalf of the insured all sums which the insured shall become legally obligated to pay as damages because of bodily injury…and… shall defend any suit against the insured alleging such bodily injury and seeking damages payable under the terms (of the policy)…”.  The policy also had an exclusion providing that it “does not apply…to bodily injury caused intentionally by …the insured.”  Dr. Gray had a reasonable self defense motive for his deliberately striking the plaintiff (who was attacking Gray in an early “road rage” incident).  What if instead, Dr. Gray was horsing around with a buddy, and swung at him with no intent to hurt the buddy at all?

We think it likely the Gray Court would have still found a duty to defend—but the courts today have drifted recently away from these broader takes on the duty to defend and the public policy concerns behind the established principles.  Rather, the insurers are gaining the upper hand at focusing the courts on more literal and narrower interpretations of the insurance contracts to narrow the scope of coverage as much as possible.  The latest case evidencing this trend is the Frake decision where the Appellate Court found that Mr. Frake was not entitled to a defense against his friend’s negligence suit claiming that he was injured in the course of horseplay.  The Frake Court found that Frake’s swing at his friend, which resulted in unintentional injury, was in fact so “intentional” as to not be an “accident” and released the insurer of any obligation to defend.  Admittedly the insuring language was written differently in Dr. Gray’s policy.  The State Farm “renter's policy” provided that there was coverage for “damages because of bodily injury caused by an occurrence.”  The coverage issue turned on the standard definition of occurrence as “an accident which results in bodily injury…during the policy year.”  So the focus was whether Frake’s “conduct” was an “accident.”  The Court found Frake intended the swing, but not the injury, and thus it was no “accident.”  Therefore there was no potential for coverage and thus, no duty to defend.  Perhaps instead, the Court should have considered whether the sequence of events (which included drunken horseplay between friends) leading to the injury constituted an accident.

The Frake Court looked with disfavor at an earlier decision, State Farm Fire and Casualty v Superior Court (Wright) (2008) 164 Cal. App. 4th 317 where the Court found the term “accident” may include instances in which “an injury is an unexpected or unintended consequence of the insured’s conduct.”  There, the insured threw the plaintiff into a pool (horseplay again) and the injury occurred when the plaintiff struck a concrete step.  Is that so very different than a drunken swing hitting a sensitive area causing unintentional injury? 

Actually a few years ago, the California Supreme Court held onto a sliver from Gray v. Zurich perhaps in its decision in Delgado v. Interinsurance Exchange of the Automobile Club of So. Cal. (2009) 47 Cal 4th 302, which held that “an insured’s unreasonable belief in the need for self-defense does not turn the resulting purposeful and intentional act of assault and battery into ‘an accident’ within the policy’s coverage clauses.”   In Delgado, the California Supreme Court noted that “[a]n accident does not occur when the insured performs a deliberate act unless some additional, unexpected, independent, and unforeseen happening occurs that produces the damage.”  Further the Delgado opinion also noted, “in the context of liability insurance, an accident is an unexpected, unforeseen, or undesigned happening or consequence from either a known or an unknown cause.”  In Delgado, the Court found no potential for coverage because the self defense belief of the insured was unreasonable.  So the case really turned on the insured’s belief—why not consider his intent then?  How is that different than his belief?  Is there ever an accident, if it starts with deliberate horseplay?  A bad throw into a swimming pool may be an accident, but a bad drunken swing is not?  Huh?

With apologies to Francois Villon, where are the snows of yesteryear?  How does a bodily injury claim on the basis of negligent conduct not even merit the merest potential for coverage?

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California has been the leader in recognizing an insured’s right to control the defense of its case where the insurer reserves its coverage rights and the outcome of the case could determine whether the coverage applies.  This is called the Cumis rule, after a 1984 case, and has since been codified as Civil Code section 2860.  That section was the result of heavy lobbying by the insurance industry and contains various provisions that inhibit the policyholder’s untrammeled selection of Cumis counsel, such as allowing the insurer to demand that such counsel “possess certain minimum qualifications” that “may include” specific elements stated in the law.  Cumis counsel must ‘cooperate fully” in providing information to the insurer except where coverage issues pertain; etc.

Perhaps the most inhibiting part of section 2860  limits an insurer’s duty to reimburse the insured for attorneys fees to “the rates which are actually paid by the insurer to attorneys retained by it in the ordinary course of business in the defense of similar claims” in the same community.”  Those fees are almost always lower than the standard fees charged to the insured by its non-insurance panel attorneys, and the client then has to swallow the difference.  And if there is a dispute about the reimbursements or their rate, the statute requires such issues to be arbitrated.

Insurers have nibbled at the edges of the Cumis rule and have tried to limit the insured’s rights to its chosen counsel in various ways.  Two recent cases have protected policyholders against that type of abuse.

Last year, in Intergulf Development Corporation v. Superior Court (2010) 183 Cal. App. 4th 16, the insurer had initially agreed to defend a construction defect case through it s own panel counsel but reserved its rights, and ultimately never accepted the case for defense and indemnity.  The insured rejected a defense by panel counsel and retained its own counsel.  the insurer made two payments of attorneys’ fees, apparently not in the full amounts of the billings and nine months apart.  After Intergulf sued it for bad faith, the insurer then sought to compel arbitration of what it called a fee dispute, claiming that Cumis counsel were charging fees in excess of the insurer’s standard rates as defined in section 2860.

The court of appeal reversed a trial court order compelling arbitration, ruling that Intergulf had begun a suit for breach of the insurer’s contractual duty to defend and for bad faith, which was notice to the insurer that the insured did not accept the insurer’s conduct as compliant with its duties under the policy and the law.  Since Intergulf claimed that the insurer had breached its duty, that issue had to be decided by the court and could not be divided by having the issue of the rates of charge determined first in an arbitration.

More recently, building on Intergulf, another court of appeal carried the same point farther.  In The Housing Group v. PMA Capital Insurance Company (2011) 193 Cal. App. 4th 1150, the underlying case had been defended by the policyholder’s chosen counsel while (it alleged) the insurer had not accepted the suit for defense.  After that case settled, the insurer stepped forward to draft the settlement agreement, paid the settlement amount, and paid only then what the insured called a “minor payment” toward the insured’s attorneys’ fees.  The insured had sued the insurer for breach of contract and bad faith; but after these events the insurer moved to compel arbitration, claiming that everything about this dispute had been resolved except the amount of attorneys’ fees it must reimburse to its insured.

The court didn’t buy that argument.  It held very clearly that “payment of defense fees at the end of the litigation [was] the equivalent of a defense denial,” and allowed the suit to proceed for breach of contract and bad faith, noting along the way that failure to pay the insured’s lawyers along the way left them “in the same position as if [the carrier] had failed to defend” entirely.

What lessons can we draw from these cases?  I think that they stand clearly for the proposition that in order to trigger its rights under the Cumis statute, section 2860, an insurer must do both of the following:

• clearly commit to defend the claim
• pay defense counsel the amounts billed, although at Cumis rates, promptly upon being billed.

In a case of mine, a Superior Court judge once ordered the insurer to pay all of the insured’s Cumis bills in a long-running, complex and costly litigation monthly upon presentation and without dispute, subject to a right to argue about their propriety later.  Unfortunately it was my opponents in that case, not my client, who got the benefit of that strong ruling. 

Policyholders should insist on getting a clear commitment from their insurers in Cumis situations, that the carriers will meet the two conditions I stated above.  Anything less is a breach of the insurer’s duties under the policy and can then be resolved in court, where there should be no arguments about reduced “similar defense counsel rates” or about late or partial payments being compliance with the insurer’s duties under the law.

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Something is seriously wrong with this case.

Where an insurer defends a claim under a reservation of rights, it may put its insured on the spot by putting this choice to him:  The insurer proposes to fund a settlement (within policy limits) with the third party claimant, but gives the policyholder notice of that claim and offers the policyholder the option of allowing the insurer to settle the claim – with the insurer then having the right to try to collect the settlement from the policyholder if the reservation of rights proves well taken – or having the insured take over the defense and the responsibility for damages, if any.  The California Supreme Court allowed this course in Blue Ridge Insurance Co. v. Jacobsen (2001) 25 Cal. 4th 489.  In Blue Ridge, the plaintiff had given a tight time limit for the settlement, and the insurer put the same limit minus 2 days to complete the settlement if the insured accepted, to its insured; but nothing in Blue Ridge discussed whether the time limits were appropriate or too short.  Nobody had raised that issue.

Now comes the case of Mr. Fahmian.  Fahmian was sued for an injury a workman suffered while working on the construction of a residence for Fahmian.  He tendered the suit to his insurer, which defended under a reservation of rights and eventually received a policy limits ($300,000) settlement offer from the plaintiff, which it put to Fahmian under the same conditions as in the Blue Ridge case:  here’s the offer; we will accept it and may sue you later for the settlement amount; or tell us to reject it and then take over the defense of the case.

Fahmian did not reply at all.  The insurance company settled a few days later and then sued Fahmian for the amount of the settlement.

That case was tried to a jury, which found many facts including this one:

Under all circumstances, did American Modern [the insurer] provide sufficient time for Sohail Fahmian to make a reasoned reply to the insurer’s proposal?  Answer:  No.

Because of this answer the court entered judgment for Fahmian.  But the court of appeal reversed.  American Modern Home Ins. Co. v. Fahmian (2011) 194 Cal. App. 4th 162.

How did the court reach that result?  By reasoning that in Blue Ridge there had been only one more day for the insured to decide whether to take the deal than had been true for Mr. Fahmian; and that nothing in Blue Ridge stated anything about what time would be sufficient to evaluate such a complex offer!

This ruling amounts to a rule that if the three conditions of the Blue Ridge case are fulfilled (reservation of rights, offer to fund but seek recovery, and insured’s right to take over the defense if he refuses), then the time allowed for the insured to consider such a complex and foreboding offer does not matter: as a matter of law, in all cases, and regardless of the circumstances, the insurer may sue the policyholder to recover the settlement.

This, despite the jury’s finding that Fahmian had not been given enough time for a reasoned evaluation of this complex and high-risk situation!

That should not be the law.  Compare it with the recent holding of the federal court of appeal in New York, which ruled under California law (which applied because the parties had made the insurance contract in California) that a very large settlement had been properly put to his insurance companies by the insured (who was defending the case subject to recovery from the insurers) because the insurers were completely up to date and closely familiar with the facts, risks and values of the case, and thus had sufficient time to evaluate the settlement.  Schwartz v. Liberty Mutual Ins. Co. (2 Cir. 2008) 539 F. 3d 135.

The Fahmian case is a great error.  The jury saw and heard evidence about the way in which the insurance company put the problem to Mr. Fahmian and found that Fahmian had not been given enough time to evaluate it.  Without discussing the evidence beyond counting the number of days, the court of appeal ruled that whether Fahmian had enough time didn’t matter: he was stuck with the whole bill.  Would the outcome have been the same if the insurance company had given Fahmian two hours, or asked him to decide on the spot?

Injustices do happen!

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In a disturbing new trend, we have seen insurers simply withdrawing from defending their insureds in the middle of the litigation.  There is substantial case law supporting the proposition that once defending, an insurer can only withdraw if a court permits it.  However, generally an insurer cannot sue its insured while the law suit the insurer is defending is still on going because that would unfairly put an insured in a two front war.  The solution for the insurer:  Put the insured in an even worse situation by yanking the defense midstream in the lawsuit!

As the primary reason a business would purchase the liability insurance in the first place is for financial protection against law suits, it hardly seems fair that an insurer can start defending but in the middle of the suit because some claims were dismissed, the insurer can just walk out and leave the insured twisting in the wind.  There are a number of courts who agree insurers cannot do so.  For example in Goerner v Axis  the directors and officers insurer settled claims against the corporation and the plaintiff amended the complaint taking most references to the corporation away.  Axis then asserted the second amended complaint (that lacked claims against the insured's company) then only asserted claims against the insured as an individual and walked away leaving the insured defenseless against the claims.  The insurer studiously ignored that the insured was sued for acts he undertook for the benefit of his company.  The insured had to settle the claims as he could not afford to fund his own defense and sue Axis for wrongfully pulling the defense.  The Ninth Circuit court of appeals agreed with the insured and applied the standard rule that where the facts support the conclusion that there was a continuing potential for coverage (in this case that the insured was acting for his company) then Axis had to continue to defend. The insured is now entitled to damages from Axis including the cost of his defense and the settlement, and perhaps tort damages as well.

We have seen other insurers attempt the same gambit--if it happens to you, call coverage counsel for assistance, as the law is on your side!

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The law is settled, though not often enforced, that an insurer defending under a reservation of rights may settle the claim and seek to recover the settlement funds from the insured if there was in fact no coverage for the claim; provided that the insurer must give the insured the option to undertake the further defense of the claim if it does not wish to risk such a claim for indemnity.  Blue Ridge Ins. Co. v. Jacobsen (2001) 25 Cal. 4th 489.  But how much notice must the insurer give the insured?
 
In a recent case, the trial court submitted to the jury the question whether the notice had been given in sufficient time to allow the insured to evaluate its options.  The jury found "no;" but the appellate court ruled that this was not a proper issue in the case.  It relied on language in the Blue Ridge case, which did not involve this precise issue, to rule that adequate notice was given when the insurer originally advised the insured that it would defend under a reservation of rights and might seek recovery of any judgment or settlement funds later.  That, the court held, was all the notice to which the insured was entitled.   American Modern Home Ins. Co. v. Fahmian (April 8, 2011) 2011 DJDAR 5152.  
 
This is a terrible decision.   In  Blue Ridge, the insurer had submitted the offer to the policyholders and engaged in some correspondence with them about the matter.  The policyholders then squarely rejected the proposed settlement, with notice that Blue Ridge might settle and try to hold them responsible for the settlement.  Only then did Blue Ridge settle the case and then sue the insureds for its recovery.  Thus, whatever language in Blue Ridge stated that the insurer had met its obligations when it had initially  advised  the policyholders that it might settle and try to recover from them, and when it later gave them notice, really did not address the question whether the insureds should be allowed sufficient time to evaluate their position before they made their decision.  The Fahmian court should have respected the jury's finding that the insured clients were not given time to evaluate the difficult situation they faced:

Their insurer had been defending the case, although under a reservation of rights and advice that it might seek recovery from the insureds if there was a pay-out.  The average insured  would be relieved that he was being defended, and not spend too much time worrying about a possible indemnity claim that might never come.  He should be given a reasonable time to evaluate his options if and when that abstract danger became real.  Interestingly, in the reverse situation the Second Circuit Court of Appeals in New York, applying California law, held recently that an insurer's refusal to fund its insured's settlement of a case in a large amount during trial was in bad faith, precisely because the limited time in which the insurer had to evaluate the settlement was sufficient. Schwartz v. Liberty Mutual Ins. Co., 539 F. 3d 135.
 
The Supreme Court should take this case and review it.

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Most people with any knowledge of insurance coverage are familiar with the Cumis rule, first announced by a California appellate court in 1984. It allows an insured whose insurer has agreed to defend a claim but reserved its right to contest coverage, to defend the case through counsel of the insured’s (not the insurer’s) choice, and requires the insurer to pay for that counsel. The California legislature soon followed up with a framework for such “Cumis” defenses, under which among other things, the insurer needs to pay only at “panel counsel” rates (usually significantly lower than general market rates), and the insurer can compel arbitration of any fee disputes for the Cumis counsel.

Obviously, this is not necessarily a bed of roses for the insured, who may have to fight the insurer about the fees and may find arbitration not the most hospitable forum. However, a new case this week should help to cut down the more unreasonable demands of insurers in this area.

The Housing Group and others sued their insurers for breach of contract, bad faith, fraud and other wrongs, apparently because the insurers failed to provide and pay for a Cumis defense against certain third party actions. The insurers responded by demanding arbitration, claiming they had paid some of the Cumis fees and this was simply a dispute about whether the payments were sufficient. The trial court denied arbitration, and the court of appeal affirmed.

Plaintiffs’ contention was that the insurer could not compel arbitration because it had never agreed to defend the underlying cases and because it had made only very partial, untimely payments after the underlying case had been resolved, instead of currently. The trial court ruled for the plaintiffs, finding that the insurers either paid no fees or paid only partially and after the case had been completed.

In a brief opinion, McGuiness, P.J., ruled that without producing evidence that it had fully paid the defense costs currently, at least to the limits of the “panel counsel“ levels, the insurer had in effect refused to defend the underlying cases. That left it in the position of having breached its contract. Thus, it could not dispute the extent of its performance through arbitration.

Thus, if in a situation that requires Cumis counsel the insurer does not unequivocally and timely pay defense costs, at least at the alleged panel counsel rates, it is simply in breach of its contractual obligations and can be sued for breach of contract, possibly for bad faith as well. Housing Group v. PMA Capital Insurance Co., Cal. Ct of Appeal, 3/25/11.

Score one for fair play to policyholders!

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