Jun 27, 2013
Policyholders purchase excess insurance policies to provide themselves with additional layers of coverage. But that excess coverage could be difficult to access under common scenarios. Accordingly, to ensure that they get the full benefit of the coverage purchased, it is critical that policyholders (1) choose their carriers carefully and (2) be aware of the specific language in their excess policies, so that they don’t end up exhausted by their excess policies’ exhaustion requirements.
The first lesson – “know your carriers” – was taught recently in the Second Circuit’s decision in Ali v. Federal Insurance Co. There, former directors of Commodore International, a computer technology company that ceased operations and filed for bankruptcy in 1994, sought coverage under the company’s D&O tower of $50 million. The problem, however, was that two of the five insurers had ceased operations and liquidated their assets. While fortunately not a frequent scenario, it is not uncommon either.
Because of the gaps in coverage caused by carrier insolvency, the directors argued that the policies of the solvent excess carriers were triggered because the directors’ liabilities had exceeded the underlying limits. The Second Circuit rejected the directors’ argument. Applying the plain language of the excess policies at issue, the court held that exhaustion occurred only by the actual payment of losses under the underlying insurance. Given the insolvencies of two of the underlying carriers, this left the directors potentially holding the bag for those limits before they could tap into the excess policies issued by the still-solvent carriers.
Notably, this result was arguably more favorable for the insureds than an earlier California decision in Qualcomm, Inc. v. Certain Underwriters at Lloyds, London. At least the Ali court did not require that payments be made by the underlying carriers, which would have been a huge problem in light of the insolvencies. Qualcomm, however, was not so lucky. In Qualcomm, which presents a second common scenario (“know your language”), the insured had reached settlements with its underlying carriers for less than policy limits and then sought coverage from an excess carrier.
The Qualcomm court, again applying the language of the excess carrier’s policy, held that excess coverage did not attach until the underlying carriers had paid the full amounts of the underlying limits. Because Qualcomm had already settled with the underlying carriers for less than full policy limits, the ruling precluded it from ever tapping in to the excess coverage, even where it paid the difference between the amounts of the settlement and the underlying limits.
The lesson for policyholders? Be prepared to face a challenge from excess insurers about the way in which coverage is triggered. Keep the excess attachment point in mind when considering a settlement with a primary or underlying carrier that may leave a gap between layers of coverage. And be prepared for the courts to focus on policy language – not public policy considerations – to govern interpretation of when an excess insurer is required to pay up.
It is important to know that the language in any given policy provision can be revised during the procurement or renewal process. Identifying and removing any problematic policy language ahead of time can avoid later disputes. Manatt offers new and existing clients flat rate policy audits by experienced partners that can identify any such problematic language, address the relevant prevailing case law interpreting such language and then work with the client and its broker in negotiating more balanced and fairer provisions.
To read the decision in Ali v. Federal Insurance Co., click here.
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Insurers can’t have it both ways.
Or as New York’s highest court explained, a liability insurer that breached its duty to defend may not later rely upon policy exclusions to escape its duty to indemnify the insured for the underlying judgment against him.
Two LLCs made a total of $2.83 million in loans secured by mortgages to a third LLC, which failed to repay the loans. Jeffrey Daniels, a lawyer for the mortgagee, failed to record the mortgages. When the loans went unpaid, one of the companies – K2 Investment Group – filed suit against Daniels, alleging malpractice.
Daniels’ insurer, American Guarantee and Liability Insurance Company, refused to provide either defense or indemnity coverage.
K2 eventually settled with Daniels for $450,000. He defaulted on payments and assigned his rights against the insurer to K2, which then filed suit against American Guarantee to recover the full $2 million of Daniels’ policy limit.
American Guarantee again refused to pay, pointing to two policy exclusions for “insured’s status” and “business enterprise,” arguing that the claims arose out of Daniels’ capacity as a member or owner of a separate business enterprise, not his work as a lawyer.
Without even reaching the application of the exclusions, the court affirmed summary judgment for K2 based on American Guarantee’s refusal to defend.
“[B]y breaching its duty to defend Daniels, American Guarantee lost its right to rely on these exclusions in litigation over its indemnity obligation,” the court said. The complaint in the underlying lawsuit against Daniels “unmistakably” pleads a claim for legal malpractice, the court noted, and while it was concededly unusual to have a principal of the borrower act as a lawyer, the parties said that’s what they did. The claim against Daniels may have been groundless, baseless, or not covered – but “it does not allow American Guarantee to escape its duty to defend,” the court said.
American Guarantee was also not allowed to assert that it would have defeated the underlying claims had it defended the case, the court added. The insurer took a risk that Daniels would obtain a judgment against him and then seek payment; in this case, the risk did not pay off.
“This rule will give insurers an incentive to defend the cases they are bound by law to defend, and thus to give insureds the full benefit of their bargain,” the court reasoned. “It would be unfair to insureds, and would promote unnecessary and wasteful litigation, if an insurer, having wrongfully abandoned its insured’s defense, could then require the insured to litigate the effect of the policy exclusions on the duty to indemnify.”
Exceptions to this rule may exist, the court acknowledged, like the possibility that coverage for intentional wrongdoing is contrary to public policy and therefore would not be covered even if the insurer had breached its defense obligation. However, no such policy arguments were available to American Guarantee.
To read the decision in K2 Investment Group v. American Guarantee & Liability Ins. Co., click here.
Why it matters: A significant victory for insureds, the K2 decision sets forth a clear rule: If the disclaimer of a duty to defend is found bad, the insurance company must indemnify its insured for the resulting judgment even if policy exclusions would otherwise have negated the duty to indemnify. The court’s ruling could result in fewer insurers taking the risk of declining to provide defense coverage, fearing the loss of their right to challenge the merits of coverage.
In a second favorable decision for policyholders from New York’s highest court, Bear Stearns may now be able to recover millions of dollars from its insurers for alleged violations of security law.
The Securities and Exchange Commission investigated the broker-dealer and clearing firm for allegedly facilitating late trading and deceptive market timing on behalf of some of its customers. Bear Stearns settled the charges, agreeing to pay $160 million as disgorgement and $90 million as a civil penalty. Like a typical deal with the SEC, the company neither admitted nor denied the agency’s findings, including that Bear Stearns “knowingly or recklessly processed thousands of late trades” and “willfully” violated various provisions of the Security Act.
Bear Stearns concurrently faced several private class actions brought by mutual funds making similar allegations. It ultimately settled those suits for $14 million. The cost of defending itself against the federal agency as well as the private suits: $40 million, the company estimated.
Bear Stearns then requested indemnification for defense costs, the disgorgement paid to the SEC (less a $10 million self-insured retention), and the cost of the civil suits from Vigilant Insurance Co. and six excess carriers.
After all the insurers denied coverage, J.P. Morgan Securities (after J.P. Morgan merged with Bear Stearns) brought a breach of contract suit against the insurers. A trial court granted the insurers’ motion to dismiss, but New York’s highest court reversed.
“[A]lthough we certainly do not condone the late trading and market timing activities described in the SEC order, the insurers have not met their heavy burden of establishing, as a matter of law on their [dismissal motions], that Bear Stearns is barred from pursuing insurance coverage under its policies,” the unanimous court said.
The insurers did not dispute that the policies covered Bear Stearns’ claims. Instead, they argued that public policy prevents coverage for intentionally-caused harm, which provided the basis for the disgorgement payment. The payment was based on the company’s ill-gotten gains and willful behavior, the insurers said.
Despite the findings of the SEC order, the court said the record failed to support the insurers’ allegations.
“[T]he public policy exception for intentionally harmful conduct is a narrow one, under which it must be established not only that the insured acted intentionally but, further, that it acted with the intent to harm or injure others,” the court said. “On the limited record before us, we are unable to say, as a matter of law, that this public policy exception clearly bars Bear Stearns’ coverage claims. The SEC order, while undoubtedly finding Bear Stearns’ numerous securities laws violations to be willful, does not conclusively demonstrate that Bear Stearns also had the requisite intent to cause harm.”
The decision noted contrary holdings from the Seventh U.S. Circuit Court of Appeals as well as state courts in California and New York, where courts determined that disgorgement payments are not insurable based on public policy.
Bear Stearns argued that the “disgorgement” label did not accurately describe the payment to the SEC and that the bulk of the payment – roughly $140 million – represented improper profits acquired by third parties, its hedge fund customers. Because it didn’t pocket the money itself, Bear Stearns said the public policy exception should not apply.
Noting the early stages of the litigation, the court agreed. The documentary evidence “does not decisively repudiate” Bear Stearns’ claims, the court said, as the SEC order “recites that Bear Stearns’ misconduct enabled its customers to generate hundreds of millions of dollars in profits.”
The court further dismissed the insurer’s attempts to disclaim coverage based on a policy exclusion where insureds gain an illegal “profit or advantage,” again concluding that the SEC order did not conclusively refute Bear Stearns’ arguments that its clients benefited from the alleged violations.
To read the decision in J.P. Morgan Securities v. Vigilant Ins. Co., click here.
Why it matters: The decision is a significant victory for Bear Stearns, and not just because of the dollar amounts at stake. The court’s ruling is highly advantageous for policyholders, determining that the “disgorgement” label assigned by the SEC to Bear Stearns’ payment was not the end of the matter. Absent conclusive evidence that could “decisively repudiate” the company’s arguments that it did not benefit from the underlying actions and the profits instead went to others, the insurer could not disclaim coverage, the court said. The ruling was not a total victory, however, as the case will now return to trial court for a battle over whether the disgorgement payment falls under the coverage of the policies.
California Civil Code section 2860, the statute that codified an insured’s right to independent counsel where a conflict of interest exists between the defending insurer and the insured, has been the subject of numerous court decisions over the years.
But two weeks ago, the Court of Appeal addressed a specific provision in that statute that doesn’t get as much play: the insurer’s right to retain counsel to represent its own interests where – as in this case – it is also obligated to hire independent counsel for its insured.
In Schaefer v. Elder, Schaefer hired Elder Construction to design and build him a home. He then sued for breach of contract and negligence, among other claims. Elder tendered defense to its insurer, CastlePoint National Insurance Company, which accepted the defense under reservation and appointed counsel of its choice to simultaneously represent both it and Elder, thus forming the familiar tripartite relationship.
The insurer also filed a declaratory action against Elder, seeking a declaration that it was not required to defend its insured in the lawsuit. Elder successfully moved to disqualify CastlePoint’s appointed defense counsel on the ground that a conflict existed within the meaning of California Civil Code section 2860 and therefore CastlePoint was required to pay for independent counsel to represent Elder’s interests alone.
Both the trial and appellate courts found that a conflict of interest existed and that the insured had a right to independent counsel. (The court’s holding in this regard is unremarkable and for that reason not discussed further here).
CastlePoint argued, however, that its appointed defense counsel was entitled to continue representing it – and it alone – in the underlying action. This argument relied on a provision in Section 2860 which permits counsel provided by the insurer to participate in all aspects of the underlying action. Subsection (f), the relevant clause, further states that independent counsel and counsel for the insurer are obligated to cooperate in the full exchange of information consistent with counsels’ ethical and legal obligations.
The Court of Appeal disagreed and held that the proper course of action was disqualification of the law firm from the action entirely, notwithstanding that CastlePoint was entitled to retain counsel of its own choice to represent its interests alone. The Court of Appeal’s holding rested on its presumption that the law firm had obtained confidential information from Elder, the insured, when it prepared responses to discovery requests, thus overriding the insurer’s statutory rights and requiring disqualification of counsel.
To read the decision in Schaefer v. Elder, click here.
Why it matters: For policyholders facing a conflict of interest with their insurer, the case provides peace of mind that their legal interests will be protected by the court. The Schaefer decision reiterates that an insurer must pay the reasonable cost of hiring independent counsel where a conflict exists between an insured and an insurer, but the court also went a step further, requiring the firm to halt its representation of even the insurer. To ensure that confidentiality was not breached and eliminate any possibility that the law firm could pass on information from its representation of the insured to the insurer, total disqualification was the appropriate remedy, the Court of Appeal said. “[W]e must assume that the [appointed] firm received confidential information from Elder when assisting Elder in, among other thing, responding to the interrogatories,” the court said. A different outcome might have been possible if the appointed firm had not simultaneously represented both the insured and insurer, but “that was not the case here.”
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