New Case: Broad Indemnity Under D&O Policy

From 3000 miles away, here is an interesting insurance coverage decision.

Genzyme Corporation had issued several classes of “tracking stocks” which “tracked” the performance of various of its divisions, in that Genzyme tracked and announced the performance of the divisions, allocating corporate expenses to them in certain proportions.  The market for the tracking stocks followed the divisions’ performance.  Eventually Genzyme exchanged the tracking stocks for shares of its general common stock.  Former holders of tracking stocks brought a class action claiming they had been defrauded in the acquisition because Genzyme had accounted unfairly for the profits of the division their stock had been tracking, thus shortchanging them in the exchange. Click here for Rebecca's Website. Does Public Policy Bar Coverage? That case settled and Genzyme then tried to recover a fraction of its costs for both defense and settlement from its sole D&O carrier, whose coverage was only roughly 1/5 of Genzyme’s total outlay.  The trial court dismissed the case on the interesting ground that Genzyme had in effect stolen share value from its tracking shareholder class and that an insurance recovery for this outlay would be an indemnity for the insured’s restoration of stolen property and thus contrary to public policy. The First Circuit reversed, Genzyme Corp. v. Federal Ins. Co. (2010) 622 F. 3d 62.  It first noted that Massachusetts “recognizes only a limited public policy exception” to the right to cover risks by insurance, “only proscrib[ing] coverage of acts committed with the specific intent to do something the law forbids.”  That standard is more generous but not really very different from California’s coverage limitations under Insurance Code section 533.  The appeals court found that the case “does not present an unjust enrichment situation” because “a corporation is neither benefited nor harmed by issuing additional shares of stock.” Genzyme thus plainly holds that D&O coverage applies to transactions in the insured’s own stock: an unusual fact situation and a strong point for broad interpretation of this insurance coverage.

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Are Policy Proceeds Property of the Bankrupt Estate? Does it Matter?

Over the last year I have repeatedly encountered the issue whether a policy of liability insurance is an asset of a bankrupt estate, and the teaser which follows that question, whether the payments under the policy are assets of the bankrupt estate. I found the issue both in lectures which I gave with one of my bankruptcy partners on the broader subject of insurance and bankruptcy, and in a specific case I became involved in. this blog seems a good opportunity to state my views on this somewhat recondite subject, without writing a brief or loading the point down with citations and close case analysis.  I am mainly concerned about Chapter 11 bankruptcies.

The outcome should really be quite simple.

First, clearly an active, unexhausted liability policy must be an estate asset. I say, must be, for several reasons. First, it is an asset of value simply because the estate would be smaller or more at risk if it wasn’t there, since it protects the estate against claims. And if the estate has debts, actual or potential, that might be covered by the policy or against which the policy might provide for defense, there again is an asset, and it has value. Certainly, a business that hopes to reorganize would want to tell its creditors that it has protection against past and current tort claims, which the insurance provides. So, despite arguments that any issues about the policy and its disposition are “really” between the insurer and the third party claimant, it is clear that the policy – the abstract contract to provide indemnity against claims – is indeed an asset of the bankrupt estate.

With respect to the policy proceeds the answer seems less clear, but it really shouldn’t be. I think that it has been obscured both by carriers who want to get out from under coverage complexities and by third party claimants who fail to recognize that they cannot collect without going through the parity-protection process that lies at the heart of bankruptcy law.

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Retreat! California Supreme Court Finds Way for Coverage Although There is No 'Suit in Court'

In 1998, the California Supreme Court turned sharply in favor of underwriters by holding that administrative orders which compelled an insured to engage in extensive, costly remediation were not covered by common CGL (Commercial General Liability) insurance policies.  Rather, the court held 4:3, using standard dictionary definitions as its tools of analysis, that both defense and liability coverage could be triggered only by a “suit in court,” defined restrictively in a later case as one seeking money damages.  The court expressly rejected the holdings of other states’ courts which required insurers to provide defense and indemnity for administrative remediation and similar proceedings, calling such reasoning “functional” or “hybrid,” although such proceedings were triggered by covered conduct (“accidents” or “occurrences”) and it was not the nature of the risk that differed but the method of enforcement by a third party claimant.  Foster-Gardner, Inc. v. National Union Fire Ins. Co., 18 Cal. 4th 857.

Foster-Gardner raised a firestorm, and eventually the Supreme Court retreated ever so slightly, allowing coverage where the policy language was a little weaker and included reimbursement of “expenses.”  Powerine Oil Co. v. Superior Court (2005) 37 Cal. 4th 477.  This month, the Court in effect, but not in words, reversed its position, finally getting in line with the rest of the country.  It held on November 18, 2010, in Ameron International Corporation v. Insurance Company of the State of Pennsylvania, No. S153852, __ Cal. 4th ___, that administrative proceedings where a judicial officer (here, an Administrative Law Judge) presides and witnesses testify, is still a “suit” which the CGL insurer must defend and indemnify.

To save its self-esteem and avoid reversing Foster-Gardner outright, the Court reached that result by a tortuous course of logic whose keystone is that under the rules of the specific administrative tribunal at issue, a complaint “requires no particular form or formality;”  the administrative board called the pleading which started the case a “complaint;” the work product looked like a complaint under the California Code of Civil Procedure even though the board involved was a federal one; and the aggrieved party had an option to bring suit or use the administrative process, although in enacting this process, Congress expressed its belief “that agency boards would handle ‘better than 90 percent of [such] contract claims.’” 

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What is a Genuine Dispute?

In the insurance world, insurers have come up with a defense to a bad faith claim which they have called the "genuine dispute" rule.  We suppose this differentiates it from an "ungenuine dispute," which is a bad faith failure to pay policy benefits for no good reason.  The "genuine dispute" defense to a bad faith claim was developed in the "first party" context -- those claims paid directly to the insured: a property loss, a disability or health insurance claim.  Chateau Chamberay Homeowners Ass'n v Associated Internet Ins. Co. (2001) 90 Cal App. 4th 335, 347 was an example of "bad facts' making 'bad law:'" there the property loss was hotly disputed and a reasonable sum was paid by the insurer after a reasonable investigation, and the homeowners association sued anyway because they wanted more money and claimed bad faith.  So the courts applied this new defense: "genuine dispute" to throw out the bad faith claim.  There the insurer had done a reasonable investigation and reasonably calculated and paid the loss it determined was owed.  Just because the insureds wanted more does not establish the insurer was in bad faith.

But as confirmed recently in Howard v. American National (2010) 187 Cal App 4th 498, this rule does not apply in all contexts.  Insurers are increasingly trying to use the "genuine dispute" shield in duty to defend third party cases involving liability policies.  It doesn't fit.  The rule is inconsistent with the duty to defend which arises wherever there is a mere potential for coverage.  So if there is a dispute over whether an insurer should defend, they should defend.  In Howard,  the court rejected the insurer's use of this defense to a bad faith claim based on its refusal to settle a third party claim because a settlement decision must be made irregardless of coverage defenses.  Johansen v California State Auto Assn.  (1975) 15 Cal 3d 9, 16.  The insurer in Howard, American National, selectively read the claimant's deposition testimony -- ignoring the evidence establishing the damages did occur during the policy period. It unreasonably disclaimed coverage on the grounds that the damages occurred only later.

How about where an insurer refuses an indemnity payment on a liability policy?  Courts have considered the "genuine dispute" defense in that context.  But a "genuine dispute" exists only "where the insurer's position is maintained in good faith and on reasonable grounds" Wilson v 21st Century Ins. Co. (2007) 42 Cal 4th 713, 723.  The defense only works if the conduct is reasonable "under all the circumstances," according to the Wilson court.  American National's conduct was found to be not reasonable as it involved the self-serving selective reading of the testimony. Howard, supra  p. 531.  We have certainly seen the insurers push the envelope to argue the failure to defend was based on a "genuine dispute" where they read the case law selectively.  Will any court uphold the defense in that context?  We don't think so, because to do so would erode decades of carefully developed insurance coverage law, but time will tell.

Insurer's Right to Reimbursement of Defense Costs: A Rule Losing Support?

One of California’s more pathbreaking rules is that an insurer must defend an entire suit if even one claim in that suit is potentially covered by a policy such as a CGL (commercial general liability) policy, but that when the case is over, the insurer may compel the insured to repay all defense costs not attributable to the covered claim. This is known as the Buss rule, after Buss v. Superior Court (1997) 16 Cal. 4th 35.

The Pennsylvania Supreme Court recently decided unanimously that it can give the policyholder the same protection without following Buss’s right to recover such defense costs from the insured, making the case that requiring a defense of the full range of claims brought against its insured is as much for the insurer’s protection as for that of the insured. The court stated that “a growing number of courts . . . have refused to follow the reasoning of Buss, and have not permitted an insurer to obtain reimbursement of defense costs of non-covered claims.” According to these courts, said the Pennsylvania court, “reimbursement is inconsistent with the broad duty to defend.” American and Foreign Ins. Co. v. Jerry’s Sport Center, Inc. (2010) 2 A. 3d 526. Unlike Buss, which saw the insurer’s defense of non-potentially covered claims as imposed by law and public policy (16 Cal. 3d at 49), the Pennsylvania court found the insurer “obligated [by the insurance contract] to defend its insured if the factual allegations of the complaint on its face encompass an injury that is actually or potentially within the scope of the policy.” This decision was recently highlighted in Insurance Litigation as indicating a turn away from Buss around the nation.

The new majority rule (if it is that), which follows Justice Kennard’s foresighted dissent in Buss, seems more attractive because it finds the insurer’s contractual duties more comprehensive than is the case under Buss. That case expressly denied that the contractual duty to defend “any suit” involving a covered claim includes the defense of non-covered claims in the same suit. (P. 48.; see Kennard dissent at p. 64, noting the majority’s silence on that issue.) It is the common wisdom that insurers’ coverage obligations are essentially derived from the insurance contract. Pennsylvania’s interpretation of that contract provides a more protective conceptual basis than Buss for fulfilling the insured’s reasonable expectations.

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Court Affirms Insurer Must Defend Potentially Covered Claims

 In a recent appellate opinion, Arrowwood Indemnity v. Travelers , published on October 6, 2010, the Second Appellate District once again affirmed the rule that an whenever the insurer "ascertains facts which give rise to the potential of liability under the policy" it must defend.  This case was actually a contribution action where a defending insurer, Arrowood, sued the recalcitrant insurer, Travelers, who refused to defend the common insured, a contractor who was accused of failing to properly remediate dry rot at an apartment building.  Ignoring the actual evidence available to it, Travelers claimed the damages happened after its policy.

In the underlying law suit, the injured party (owner of the building) did claim initially that the negligence was in 2002 and later (Arrowood's policy years), but introduced evidence at the trial of the insured's work going back to 2000 and problems dating from then (Travelers' policy years).  The verdict form, in the underlying trial, asked general questions about liability and damages not tied to specific later dates mentioned in some of the earlier verdict questions.   That was enough to tag Travelers.  The court also determined that Arrowood need only make a prima facie showing of potential for coverage in the Travelers' year, which it easily did, and then it was up to Travelers to negate the potential.   Impossible on these facts.  The same relative burdens of proof would apply to an insured seeking coverage from a recalcitrant insurer.  Good call.

When Does An Insurer Waive its Subrogation Rights?

OK, so how many insurance coverage published opinions begin with “What the Heck?!?” Not too many (although given some of the arcane inverted logic that is sometimes in play one would expect a few more). The case of Essex Insurance Company v. Richard Heck, MD filed on July 29, 2010 (2010 DJAR 11835) does begin with this memorable phrase and serves as a warning to insurers as well as any other litigants who take contradictory positions in multiple simultaneous or seriatim lawsuits. There the Fifth Appellate District affirmed a summary judgment by a subrogee against an insurer’s subrogation action, on the basis that the conduct of the insurer supported the trial court’s determination that the insurer impliedly waived its subrogation rights. This was a case of first impression on this precise issue although the general concept of implied waiver was applied in an earlier case to an insured who impliedly waived his “bad faith” claim when he accepted an insurer’s settlement of the third party claim (in the absence of any evidence of coercion, duress or fraud). United Services Automobile Assn v. Alaska Ins. Co. (2001) 94 Cal App 4th 638.

Before reciting the facts of this twisted tale, we will summarize who was suing who and for what. The matter is complicated because of the rather tortured gyrations the insurer went through to avoid paying the eventual judgment against its insured. Initially the insurer did provide defense counsel for its insured, but it pursued a declaratory relief case against its insured at the same time the claimant’s suit was pending. The insurer stubbornly refused to pay the judgment awarded to the claimant after trial. When cornered after the claimant brought fraud and bad faith claims, the insurer ultimately paid less that the claimant’s judgment, but failed in its effort to pass that cost to a subrogee (a third party allegedly responsible for the injury to the claimant).

The suits discussed in this opinion include: 1) the injured claimant’s premises liability suit against the insured(s); 2) the insurer’s declaratory relief suit against the insured(s); 3) the injured claimant’s suit for bad faith and fraud against the insurer and finally 4) the insurer’s suit against a third party (who was allegedly responsible for the claimant’s injury).

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Coverage for Pre-lawsuit Procedures

Defying common sense, an insurer who issued a commercial general liability insurance policy to a subcontractor refused to defend the contractor in a pre-litigation statutorily mandated settlement proceeding, known as the Calderon Process, which must precede all construction defect suits brought by planned unit development associations. StarNet Insurance Company’s excuse was that the Calderon Process did not meet its policy definition of “suit” notwithstanding that the definition included not only “a civil proceeding in which damages because of …property damage…are alleged.” but also included: “An arbitration proceeding…(and/or) Any other alternative dispute resolution proceeding in which such damages are claimed and to which the insured submits with our consent.” Say what?

This rather jaded approach to their policy allowed a Fourth Appellate District Court to begin their published opinion in Clarendon America Insurance Company v,. SarNet Insurance Company issued on July 27, 2010 (2010 DJAR 11645) with the coveted phrase: “We hold, as a matter of first impression, the provision in a commercial general liability policy requiring the insurer to “defend the insured against any ‘suit’ seeking …damages” to which the insurance applies includes the duty to defend the insured in proceedings under the Calderon Act…” After noting the parties did not contend that definition no 2 (arbitration) applied as the Calderon Process was not an arbitration, the Appellate Court did not need to get to the third alternative definition of suit, (“alternative dispute resolution proceeding”), because a Calderon Process easily fits into the ambit of a “civil proceeding in which damages” are alleged. This is because, as the Court put it: “The Calderon Process is more than a prelitigation dispute resolution requirement: It is part and parcel of construction or design defect litigation initiated by an association and, as such, cannot be divorced from a subsequent complaint.” Thus this Court easily concluded that the parties to the StarNet policy intended that StarNet commercial general liability policy would have a duty to defend the insured in the Calderon Process.

We Need to Read Insurance Policies Like Lay Folks Do!!

Lawyers who regularly deal with insurance coverage disputes are always tempted to parse the sometimes nearly unintelligible language of the insurance policy to determine whether and what kind of coverage exists.  Indeed, courts can fall into that same temptation, e.g., Foster-Gardner, Inc. v. National Union Fire Ins. Co. of Pittsburgh, Pa. (1998) 18 Cal. 4th 857, holding that the term “suit,” which is what the insurer agreed to defend, must mean a suit in court and not an administrative enforcement action.

A new case is a refreshing reminder that courts do not always view policyholders’ rights so narrowly.  In Lee v. Fidelity National Title Insurance Company (September 16, 2010), 10 DJDAR 14590, the trial court denied coverage to a title insurance holder.  She had bought property which had been described in the escrow by metes and bounds and by assessor’s plot numbers.  Years later, a problem developed whether a neighbor’s improvement was on the owner’s property.  It turned out that under the metes and bounds description, the improvement was on the neighbor’s land although the assessor’s plot numbers, erroneously, showed the property to be owned by the insured.  The title company denied coverage, claiming that the metes and bounds description – which had just caused the insured to lose the property – defined the coverage under the policy language and controlled; and the trial court agreed.

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You Can Undo a Settlement Without Returning the Settlement Funds

Some times, the law's technicalities can create headaches. A recent California Supreme Court Case is an example.

The Northridge earthquake happened in 1994 and caused vast damage. Now, sixteen years later, the Supreme Court has just returned an insurance coverage case relating to claims of earthquake damage of that time to the lower courts , directing the case to start over again. The technicalities seem to drown out the merits of the case; but when all is said and done the parties should be ready for the next round.  

Northridge Village Homeowners Association owns the common area of a condominium complex  which suffered damages from that earthquake. State Farm Fire & Casualty Company was its property insurer. After several false starts, and -- as the HOA now alleges -- after State Farm advised it that its coverage was about $4.7 million with a 10% deductible, the HOA settled its property damage claim with State farm for about 70% of the available coverage. The settlement agreement contained the usual release of all known and unknown claims, waiving the rights of the insured under Civil Code section 1452, which would otherwise preserve claims unknown at the time of settlement.

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