Insurance Law Developments

SC Supreme Court Says Insurers Can’t Cloud Allocation of Covered and Non-Covered DamagesThe South Carolina Supreme Court’s decision in Harleysville Insurance Co. v. Heritage Communities, Inc., modified July 27, 2017, continues a trend of decisions aimed at preventing an insurer from acting in its own interest to the detriment of its insured when the insurer controls the defense of underlying claims against the insured. Although the far-ranging opinion in Harleysville tackles a number of important coverage issues, perhaps the most salient is a renewed emphasis on the insurer’s duty to inform its insured of the need to allocate damages in underlying litigation to differentiate between covered and non-covered losses in a jury award.

In Harleysville, the jury awarded $10.75 million in actual damages against a developer in two suits arising from defective condominium construction. These damages were based on the cost to repair defects, and included costs to replace faulty workmanship, as well as costs to repair damage to the condominium from water intrusion. The verdict did not distinguish between these costs. Because replacement of faulty workmanship was not covered under the developer’s liability insurance policies, in the ensuing coverage litigation, the insurer contended that it was not obliged to provide coverage for this portion of repairs. The court, however, found that the insurer lost the right to contest this issue when it failed to notify the policyholder of the need to allocate the verdict in the underlying suits.

The problem of parsing covered and non-covered losses in a verdict is not new. Since at least Duke v. Hoch, 468 F.2d 973 (5th Cir. 1972), courts have complained that it is virtually impossible to “determine the particular amount that happened to be in the jury’s mind” in subsequent coverage litigation. Where there was no effort in the underlying suit to determine the jury’s intent in making the award, assignment of the burden of proof between the insurer and policyholder is therefore potentially dispositive of the allocation. While it is typically the insured’s burden to show that damages fall within the coverage grant, a number of courts have recognized the inherent conflict of interest where the insurer controls the defense of the litigation but fails to obtain an allocated verdict. If the burden remained with the policyholder under these circumstances, the insurer could obtain a windfall from its own failure to clarify the composition of the award.

Some courts have responded to this problem by shifting the burden to allocate covered and non-covered losses from the insured to the insurer when the insurer fails to either obtain an allocation of the verdict in the underlying litigation or notify its insured of the need to do so. In Magnum Foods, Inc. v. Continental Casualty Co., 36 F.3d 1491 (10th Cir. 1994), the Tenth Circuit held that where the insurer controlled defense of the litigation but failed to request special interrogatories or a special verdict to allocate damages, it bore the burden of demonstrating that the basis of the award fell outside coverage. In Duke v. Hoch and Harleysville, the courts did not mandate that the insurer must itself seek an allocation, but found that the insurer must provide notice to the insured of the need for allocation in its reservation of rights. Harleysville found that the insurer’s blanket reservation of rights letter did not meet this standard, as it did not “inform the insureds that a conflict of interest may have existed or that they should protect their interests by requesting an appropriate verdict.” The insurer therefore lost the right to contest this issue and was required to cover damages for faulty workmanship that would otherwise have fallen outside of the policy.

Left unresolved by the opinion is precisely how, and by whom, the allocation of the verdict will be accomplished. In Duke v. Hoch, obtaining an allocated verdict would have been fairly simple, since the non-covered damages related to a particular claim against the insured; thus, the jury could have been asked to specify the portion of damages awarded on the basis of that claim. But in Harleysville, parsing out the covered and non-covered damages would have required specific findings as to which costs were required to replace the insured’s faulty work product, and which costs pertained to repairs for water intrusion. For the jury to make an informed decision on these issues, defense counsel would need to tailor the testimony of its witnesses, and possibly even modify its closing argument.

In a given case, the facts relevant to such allocation might well be contested between the insurer and the policyholder, and it is doubtful whether defense counsel retained by the insurer will be able to navigate this potential conflict of interest. Because Harleysville focused on the insurer’s duty to notify the policyholder of the need for an allocated verdict in its reservation of rights, insurers may argue that it is the policyholder’s responsibility to engage independent defense counsel if it wants to obtain such an allocation. But if the insured must pay for its own attorneys to handle the litigation, it has been deprived of a key benefit of coverage, namely the insurer’s duty to provide a defense. The policyholder could obtain independent counsel of its own choosing, and ask the insurer to reimburse reasonable fees. A policyholder, however, can expect the insurer to resist any arrangement under which it would pay for litigation expenses exceeding those of its regular insurance defense counsel, or for expenses incurred to present evidence adverse to the insurer’s own coverage position. As insurers modify their reservation of rights letters to meet the prescriptions in Harleysville and similar cases, policyholders must be vigilant for an insurer’s communication that allocation is needed, and insist that insurers discharge their defense obligations under the policy.

Beware of Prior Act Exclusions and Retroactive Dates When Procuring or Renewing CoverageAn 11th Circuit decision issued earlier this year serves as a reminder of the importance of carefully evaluating time-based exclusions and retroactive dates when procuring or renewing coverage. Liability policies such as directors’ and officers’, private entity, and professional liability policies provide coverage for claims made and reported during the policy period (or an extended reporting period) regardless of the date of the underlying alleged wrongful act. This coverage is not unlimited, however, and an insurer selling a policy with a Prior Acts Exclusion may well deny coverage for alleged wrongful acts that purportedly “arise out of” even tangentially connected conduct that first happens before the policy’s retroactive date. Insurers will do so even though a reasonable insured would not make any connection between the otherwise covered wrongful acts and prior conduct. In Zucker v. U.S. Specialty Insurance Co., the 11th Circuit endorsed this very approach. The court relied on a broad “Prior Acts Exclusion” combined with a retroactive date to eliminate coverage for actions that occurred after the retroactive date and that led to a claim first brought during the policy period.

Zucker (the bankruptcy plan administrator) alleged that corporate officers fraudulently transferred monies from BankUnited because they transferred the money while the bank was insolvent. The insolvency and the alleged fraudulent transfers occurred during the policy period, and the officers timely submitted their claims for coverage after Zucker sued them for the fraudulent transfers. The insurer denied coverage for the lawsuit on the grounds that the fraudulent transfer claims required the insolvency, and the insolvency resulted from the officers’ mismanagement of the bank before the retroactive date. Using a broad “Related Claims” exclusion, the insurer connected the insolvency with the mismanagement and denied coverage. The 11th Circuit agreed. Broadly construing the phrase “arising out of” in the Prior Acts Exclusion under Florida law, the court described the insolvency as an “essential element” of Zucker’s claim that “has a connection to some wrongful acts” of the officers and directors that “occurred before the policy’s effective date.” The court concluded that the Prior Acts Exclusion barred coverage:  “Given that, Zucker’s fraudulent transfer claims do share ‘a connection with’ wrongful acts covered by the Prior Acts Exclusion.” The court noted that the governing Florida law broadly construed “arising out of” to encompass virtually any connection and imposes a standard that “is not difficult to meet.”

Tellingly, the 11th Circuit recounted the bank’s decisions regarding placement of the coverage. When offering the coverage to the bank, the insurer offered a choice between two policies:  “one with a Prior Acts Exclusion (barring coverage for losses attributable to conduct of the officers before November 10, 2008) and one without the exclusion.” The premium with the exclusion was $350,000; the premium without the exclusion was $650,000. Although the bank purchased other coverage enhancements and doubled the policy limits, resulting in a final premium at $700,000, the bank’s decision to accept the exclusion proved fatal to coverage.

This case should serve as a stark reminder to policyholders to carefully examine their policies and insurers’ coverage proposals. Policyholders should resist or limit as much as possible any terms designed to restrict the time period relevant to coverage, including Prior Acts Exclusions and retroactive dates. Certain seemingly innocuous terms can result in an unexpected and painful outcome that far overshadows any upfront premium savings.

The Perils of Late NoticeAs every policyholder should know, purportedly “late” notice under claims-made insurance policies can eradicate coverage – even if the policyholder purchases successive policies from the same insurer. Alaska Interstate Construction, LLC (AIC) faced this very situation, and lost coverage in a recent unpublished Ninth Circuit decision (Alaska Interstate Construction, LLC. V. Crum & Forster Specialty Insurance Company, Inc.). AIC purchased successive professional errors and omissions liability policies from Crum & Forster Specialty Insurance Company, Inc. (C&F). C&F issued an initial policy for the policy period of December 1, 2011, to May 1, 2013, and then a renewal policy with a policy period of May 1, 2013, to May 1, 2014. Thus, for the period from December 1, 2011, until May 1, 2014, C&F insured AIC. On January 10, 2013, during the initial policy period, a third party made a claim against AIC. AIC did not report the claim during the initial policy period but instead reported the claim on June 19, 2013, during the renewal policy period. The court found no coverage because AIC received the claim in one policy period but reported the claim in the subsequent policy period.

In a creative attempt to avoid this outcome, AIC argued that the policies’ vague definition of “policy period” as “the period shown in the Declarations” did not limit the “Declarations” to one specific policy period, and that the policy period could reasonably be interpreted as encompassing both the initial and renewal policy periods. The Ninth Circuit unequivocally rejected this argument and instead treated the policies as two separate contracts without a continuous policy period.

Ironically, AIC’s renewal of the policy placed it in a worse position than had it walked away. The initial policy, which expired on May 1, 2013, included a 90-day automatic extended reporting period (ERP) when the policy “is canceled or not renewed by [C&F] for any reason except non-payment of premium.” AIC argued that if the policies are viewed separately for purposes of determining the policy period, then the initial policy was effectively cancelled when its policy period ended, thus invoking the automatic ERP, which was in effect when AIC reported the claim to C&F. The Ninth Circuit rejected this reasoning: “the plain language of the policy states that cancellation and non-renewal are the events that trigger the ERP. Thus, because AIC renewed its policy, the ERP did not apply.”

This case is just one of many decisions depriving policyholders of coverage under claims-made policies due to the timing of notice. To avoid this outcome, commercial policyholders should ensure that they report all claims asserted against them during the operative policy period. They should also carefully evaluate potential liabilities to determine whether to give notice of circumstance under a policy before the end of the policy period. This due diligence is essential – for with claims-made policies, late is not better than never.

Recent Case Highlights Insurance Recovery Strategies and Pitfalls for Commercial PolicyholdersA recent Minnesota coverage decision provides guideposts for a commercial policyholder’s proper handling of an insurance claim as well as a cautionary tale regarding an excess insurer’s attempt to readjudicate liability in a subsequent coverage action.

In RSUI Indemnity Company v. New Horizon Kids Quest, Inc., the commercial policyholder (1) promptly and properly notified its primary insurer and its excess insurer (RSUI)  of a potentially covered claim; (2) involved those insurers in the underlying defense strategy; and (3) stipulated to liability in a manner that avoided a potentially applicable exclusion (and with the insurers’ consent). Nevertheless, after the verdict, the excess insurer attempted to readjudicate liability in a coverage action by arguing that an exclusion applied. The court, in a thoughtful decision, rejected the excess insurer’s arguments and granted summary judgment to the policyholder.

The Underlying Case

In the underlying case, a child’s parents sued the policyholder alleging that their 3-year-old son was physically and sexually assaulted by a 9-year-old child while both were under the policyholder’s care, custody, and control. In consultation with both the primary insurance insurer and the excess insurer, the policyholder did not contest liability, conceded that an “assault” occurred, but disputed the “nature, type, and extent of” the injuries sustained by the minor child.  The jury awarded $13 million in damages against the policyholder (later reduced to $6 million after a second trial), but did not determine whether a “sexual assault” occurred because it was not asked to do so. After the jury award in the underlying case, the excess insurer filed a coverage action seeking to avoid paying the excess verdict by invoking a sexual abuse exclusion.

The Coverage Litigation

In the coverage litigation, the court determined that although the jury was presented with evidence of sexual assault in the underlying case, the presentation of evidence alone was insufficient to support the excess insurer’s exclusion defense because the jury was not asked to determine whether a sexual assault occurred. The court explained, “With no insights into the jury’s method of awarding damages, and no effort by anyone—including RSUI—to ask the jury to parcel out its award, any conclusion at this stage that same or all of the damages arose from sexual abuse—whether by the undersigned or a new jury—would constitute pure and unfettered speculation.”  Additionally, the court noted that the excess insurer participated in both trials in the underlying litigation (more substantially in the second trial) and consented to the policyholder’s admission of liability.

Guideposts and Warnings for Commercial Policyholders

Promptly and Properly Notify All Insurers Potentially on the Risk

Providing prompt notice to all insurers on the risk, including excess insurers that may be impacted by a judgment or settlement, can avert unnecessary coverage litigation or at least place the policyholder in a better position if coverage litigation later ensues. In this case, the policyholder promptly and properly notified both its primary insurer and its excess insurer, thus avoiding a preemptive challenge to coverage based on late notice or failure to comply with applicable notice provisions. Although not apparent from the court’s decision, providing prompt notice better positioned the policyholder in the later coverage litigation as well by focusing the insured on its insurance coverage as it formulated its defense to the lawsuit. In addition, an insurer’s failure to assert certain defenses or, conversely, its participation and endorsement of particular defense strategies, may estop the insurer from raising particular defenses in a subsequent coverage litigation, as occurred in this case.

Mitigate Risks Arising from Different Defenses Asserted by Excess Insurers

As this case demonstrates, primary and excess insurers may take different coverage positions, even when the excess policy follows form or incorporates language similar to the primary policy. This decision does not reveal whether the excess policy followed form or included a different exclusion.  If the former, the excess insurer adopted a coverage position different than the primary insurer based on similar policy language. A primary insurer with the duty to defend must support defense strategies that are in the policyholder’s best interest even if those defenses are detrimental to the insurer’s potential coverage defenses. This conflict – which must be resolved in favor of the policyholder where the duty to defend is concerned ­– may preclude the primary insurer from asserting certain exclusions that require a liability determination. In contrast, an excess insurer with no defense obligation may not face the same conflict of interest and therefore may be better positioned to assert certain coverage defenses not available to the primary insurer bearing the defense obligation.

A savvy policyholder can mitigate certain excess insurer coverage defenses by involving the excess carrier in the defense of the underlying claim (or providing an opportunity for the excess carrier to decline to be involved). In this case, the policyholder promptly notified the excess insurer, consulted the excess insurer during the underlying litigation, and obtained the excess insurer’s approval of the admission of liability – critical facts that the court relied on when ruling in favor of coverage. By involving the excess insurer, the policyholder preserved coverage under both policies. Policyholders should be aware that different insurers may take different coverage positions – even on the same policy language – and take steps to mitigate that risk, as did the policyholder in this case.

Coordinate Defense and Insurance Recovery Strategies

Commercial policyholders can minimize uninsured losses by coordinating defense and insurance recovery strategies. While an insurance recovery strategy should not drive the defense of an underlying claim, coordination of the best available defenses to the underlying case with available insurance recovery strategies can minimize a commercial policyholder’s ultimate exposure. In this case, the policyholder coordinated its defense and insurance recovery strategies by admitting liability but disputing damages. This approach is an important strategic option available for policyholders seeking to maximize insurance recovery in litigation that involves both covered and uncovered claims. Admitting liability to avoid an unfavorable jury finding on an uncovered claim can help preserve insurance coverage for the entire liability. While asserting a strong liability defense for the uncovered claim or settling the entire matter may be a preferable option when available, an admission of liability can be an effective risk mitigation strategy. In a minority of cases, policyholders may adopt defense strategies that maximize insurance recovery at the expense of the underlying defense. To minimize liability and maximize insurance recovery, policyholders should carefully consider the risks and rewards of available insurance recovery strategies early in the defense of the underlying litigation (if not before).

Follow Form Coverage Does Not Always Follow Form

This case also highlights the discrepancies that can sometimes arise between different layers of insurance. Although the primary insurer defended under a reservation of rights and subsequently paid its share of the judgment, the excess insurer disputed coverage based on the sexual assault exclusion. The court’s decision does not specify whether the primary insurance policy included a sexual assault exclusion, but does note that the primary insurer defended under a reservation of rights. Assuming that the primary policy did not incorporate a sexual assault exclusion, the policyholder could have avoided the coverage with its excess insurer by ensuring that its excess policy followed the primary policy form without any additional exclusions. Although there are exceptions to every rule, policyholders rarely benefit from excess coverage that is more restrictive than their primary coverage. Commercial policyholders should carefully review their coverage towers to ensure that their insurance protection is coordinated across the primary and excess layers.

Past Insurer Cooperation Does Not Guarantee an Insurance Recovery

Finally, an insurer’s cooperation in the defense of an underlying claim does not preclude that insurer from later disputing coverage, especially when the insurer issues a reservation of rights letter. Disputes can arise despite an ongoing business relationship between the policyholder and the insurer. In this case, the excess insurer received prompt and proper notice of the claim, monitored the litigation through the first trial, consented to a defense strategy, actively participated in the defense of the second trial, and then denied coverage only after the second trial. These events underscore the need to proceed carefully when seeking insurance coverage. The outcome in this case may not have been the same if the policyholder had not complied with its notice obligations and involved the excess insurer in the underlying case.

erosionA recent Fifth Circuit case highlights the potential risks of purchasing a defense-within-limits policy: If an insurer is obligated to hire independent counsel due to a conflict of interest, that counsel’s fees may erode your policy limits.

When an insurer accepts coverage of a liability claim, the insurer typically has the right to choose counsel to defend the policyholder as well as to control the defense. When an insurer defends under a reservation of rights, however, a conflict of interest arises between insurer and policyholder. Many states obligate the insurer in this situation to pay for independent defense counsel selected by the policyholder to obviate the conflict. For example, in Mississippi, a policyholder’s right to independent counsel paid by the insurer is known as the “Moeller” rule.

The Fifth Circuit recently decided just how far the rule extends. In Federal Insurance Co. v. Singing River Health Systems, the insurer agreed to defend a public hospital system, Singing River Health System (SRHS), and various officers, under a reservation of rights in multiple lawsuits stemming from alleged underfunding of a pension plan. The policy and policy application clearly stated that defense costs would erode the limits of liability. SRHS nevertheless argued that defense costs paid under Moeller should not erode the policy limits.

The policy defined covered “loss” to include defense costs that SRHS was “legally obligated to pay.” Because the insurer, not SHRS, is “legally obligated to pay” for Moeller counsel, SRHS reasoned that such costs should fall outside the limits. The federal district court agreed, holding that at a minimum, the phrase “legally obligated to pay” was ambiguous and should be construed in favor of SRHS.

During oral argument before the Fifth Circuit, the insurer reported that it had expended over $3 million in defense costs on a policy with $1 million limits.

The panel held that the district court’s ruling pushed the Moeller rule too far. The court cited a more recent Mississippi Supreme Court decision holding that the policyholder must meet the policy’s deductible requirement before the insurer’s Moeller obligation is triggered. The Fifth Circuit held that the insurer’s duty to pay for independent defense counsel is similarly subject to the terms of the policy, including the policy limits. The court also rejected SRHS’s public policy arguments against enforcement of the defense‑within-limits provision.

At oral argument, one of the judges quipped that perhaps SRHS underfunded its insurance coverage. While not apropos from a legal perspective, as a practical matter it is a valid point. SRHS had the option to purchase a separate limit of liability for defense costs and chose not to do so. However, even if there had been a separate limit, defense costs were triple the policy limit with the underlying litigation still ongoing. Failure to realistically assess risks and secure sufficient insurance coverage for those risks can be the ultimate peril.

RIMS 2017: Risk Revolution is less than two weeks away… are you going? Bradley’s Policyholder Insurance Coverage team is!

When: April 23-26, 2017

Where: Philadelphia, PA

What: Visit us at Booth 2734 (map of exhibit floor) to meet some of Bradley’s coverage attorneys and learn about key issues facing policyholders in today’s complicated insurance landscape. We look forward to seeing you at RIMS 2017.

For more information about the event visit the RIMS 2017 website.

Are Federal Courts Increasingly Likely to Grant Rescission of Insurance Contracts?Recent court decisions across a variety of industries highlight the importance of submitting complete and accurate insurance applications and renewals. When submitting an application for insurance, the applicant should accurately and completely answer all application questions and fulfill all document and data requests. Oversights, misstatements, and missing documents can lead to rescission of the insurance policy and leave the organization or individual without any coverage for a claim.

When faced with a claim or potential claim, insurance companies can and will review both the applicable policy, policy applications, and the underwriting files to determine potential defenses to coverage. After a claim arises, an insurer that discovers a discrepancy in the application, renewal, or underwriting file will likely attempt to rescind the policy and deny coverage for the claim, potentially unraveling the organization’s risk management planning and creating substantial, unexpected liabilities.

Under the wrong circumstances, insurance company rescission arguments can persuade a judge or jury because the insurance company may create the impression that the organization misled or misrepresented key details to obtain lower premiums. The insurer’s ability to frame a coverage dispute as a referendum on the policyholder’s honesty, rather than a simple contract dispute, can profoundly impact the course of the litigation. Some courts’ apparent willingness to more liberally permit rescission presents a worrying trend that should be closely monitored, coupled with a thorough review of policy applications to mitigate the potential of rescission.

Five Best Practices to Minimize Rescission Risk

  • Carefully review the reported values and conditions of assets in other company documents, especially publicly reported documents (because these documents are often incorporated by definition into the application), and ensure that the values and conditions reported on insurance applications are consistent and accurate.
  • Assess and review the scope of the organization’s operations during policy renewal to disclose all relevant business activities and avoid inadvertent omission of related business operations and new business operations to avoid an insurer contention that the organization misrepresented the scope of its operations in its renewal application.
  • Disclose prior related incidents or losses to ensure that an insurer cannot use an earlier claim or loss to rescind the policy.
  • Do not rely on good intentions as a defense to rescission. Under some state laws, courts may uphold rescission based on the insured’s material misrepresentation even if the alleged misrepresentation was accidental and not intentional.
  • Be aware of differing legal standards for disclosure of material information in insurance applications. An applicant should always answer questions fully and accurately and provide all requested supporting documents. In certain circumstances, however, such as the marine market and some foreign markets, the applicant may have an affirmative duty to disclose all material information, regardless of whether the underwriter requested the information. An insured must know whether a heightened duty to disclose applies under the governing law.

Recent Cases Underscore the Need for Accurate Applications and Disclosures

Failure to Report Prior Losses Leads to Rescission of Policy 

Just this month, the Third Circuit Court of Appeals affirmed a lower court decision rescinding a product contamination insurance policy based on four material misrepresentations in the policyholder’s application upon which the insurer relied.  In H.J. Heinz Co. v. Starr Surplus Lines Insurance Co., following an advisory jury’s determination that the policyholder failed to disclose at least two prior incidents involving contamination of baby food, the federal judge upheld rescission even though the insurance company purportedly ratified the policy by invoking the policy’s choice‑of‑law provision. On appeal, the policyholder argued that the insurance company’s attempt to enforce the choice‑of‑law provision in the policy ratified the policy and precludes rescission. The policyholder also argued that the insurance company knew of the prior product contamination issues through news reports in the insurance company’s file. The appellate court rejected both of these arguments and in strong language criticized the insured for failure to disclose prior losses: “For the ten-year period identified in the Application, Heinz disclosed only one loss in excess of a $5 million SIR. In reality, however, Heinz experienced three losses exceeding a $5 million SIR, totaling more than $20 million, a figure far exceeding the single $5.8 million disclosed loss. Heinz’s misrepresentations were of such magnitude that they deprived Starr of ‘its freedom of choice in determining whether to accept or reject the risk upon full disclosure of all the facts which might reasonably affect that choice.” The appellate court also found that the evidence established the insurer’s reliance on these misrepresentations: “Starr underwriters testified that they looked to Heinz’s loss history in calculating the appropriate risk and conducting their loss ratio analysis.”

This appeal presents an interesting test case: The policyholder’s position that rescission is inappropriate because the insurance company ratified the contract is legally sound, but the insurance company’s argument that the omission of two potentially related prior incidents from the application highlights the risks of incomplete disclosures in insurance applications. The Third Circuit held oral argument on December 6, 2016, and took the matter under advisement.

Failure to Disclose Additional Business Activities Leads to Rescission of Policy

The Seventh Circuit Court of Appeals recently upheld the rescission of an insurance policy sold to a doctor and a related MRI center because both made material misrepresentations in their insurance policy applications. In Essex Insurance Co. v. Galilee Medical Center S.C., the court, applying Illinois law, upheld rescission because the applications stated that the doctor and the MRI center did not perform non‑traditional weight loss procedures or treatments, but a post-claim investigation indicated otherwise.

After a patient sued the doctor and the MRI center for complications from a non-FDA approved weight loss treatment, the court found that the doctor recommended non‑traditional weight loss procedures and treatments to a client while at the MRI center and then completed those treatments at a different location. The court rejected the MRI center’s argument that the doctor performed the non-traditional weight loss procedure at another location and that the doctor’s actions at the MRI center were limited to making a referral to himself for the non‑traditional weight loss procedure.

Incorrect Reporting of Property Condition Leads to Rescission of Policy

The Second Circuit Court of Appeals affirmed a lower court’s decision to rescind two insurance policies for misrepresentations regarding the condition of a dry dock that sank after the policyholder attempted to repair the structure. In Fireman’s Fund Insurance Co. v. Great American Insurance Co., two insurance companies, an excess property insurer and a marine pollution insurer, sought rescission of their respective insurance contracts because the policyholder’s insurance application and renewals valued a dry dock owned and operated by the policyholder at several million dollars, when internal documents show that, due to deterioration and lack of repairs by a prior owner, the dry dock had no monetary value.

Applying admiralty law, which requires a heightened duty of “utmost good faith” of disclosure on the part of the applicant, the court rescinded the marine policy because the policyholder, over a period of multiple years, reported that the value of the dry dock as if it were in good condition when it was in need of repairs. The court upheld rescission despite the policyholder’s argument that it provided all the information requested on the insurance application and the underwriter did not request surveys or additional information about the condition of the dry dock. This holding highlights the need to ascertain when a heightened duty to disclose applies for certain types of policies.

Similarly, applying Mississippi law, the court upheld rescission of the excess property policy because the applicant reported the value of the dry dock as if it were in good condition and reported the likelihood of a maximum probable loss – the dry dock sinking – as an “extremely low probability.” The court rejected the applicant’s arguments that it did not complete an application, but rather provided a property insurance submission of its own creation, and that the insurer did not request additional information about the condition of the dry dock in light of the “material misrepresentation” of the condition of the dry dock in the insurance submission. The court rescinded the policy even though the insurer did not intend to deceive the insurer. The court did not require intent or a reckless disregard of the facts often required for a misrepresentation defense.

More States Applying “No-Prejudice Rule” on Notice to Claims-Made PoliciesIn a majority of states, an insurer cannot deny coverage based on a policyholder’s late notice of a claim without showing that the delay prejudiced the insurer. This “notice-prejudice rule” is an advance over the traditional “no-prejudice” rule that allows insurers to deny claims based on late notice regardless of the circumstances leading to the delay. The Wyoming Supreme Court, the most recent court to adopt the notice-prejudice rule, described the rationale for the rule in Century Surety Company v. Jim Hipner, LLC: most policyholders lack the leverage to negotiate for better policy terms; forfeiture of coverage on a mere technicality gives an unwarranted windfall to the insurer; and states have an interest in ensuring that accident victims are compensated. The court also held that a policy provision attempting to “contract around” the notice-prejudice rule violated public policy.

Nevertheless, more states are limiting the notice-prejudice rule to occurrence policies and applying the no-prejudice rule to claims-made policies. The New Jersey Supreme Court  applied the no-prejudice rule to a claims-made policy that required written notice of a claim “as soon as practicable” in Templo Fuente De Vida Corp. v. National Union Fire Insurance Co.  The court agreed with National Union’s contention that the policyholder’s notice of a D&O claim more than six months after service of the lawsuit violated the notice provision. Despite longstanding precedent in New Jersey following the notice-prejudice rule, the New Jersey Supreme Court refused to apply the notice-prejudice rule to claims-made policies with clear and unambiguous terms. The court discounted the equitable concerns behind the notice-prejudice rule because purchasers of claims-made policies are “knowledgeable insureds, purchasing their insurance requirements through sophisticated brokers.”

Despite this court’s application of the no-prejudice rule to a claims-made policy, policyholders should not presume this is a blanket rule, even in New Jersey. In Templo Fuente, the policyholder gave no reason for its delay in providing notice. An explanation could have dissuaded the court from denying coverage. In addition, not all purchasers of claims-made policies are “sophisticated.” Finally, the goal of avoiding an unwarranted windfall to the insurer appears to equally apply to a claims-made policy. Unlike an occurrence policy, which can be triggered years after the policy period expires, coverage under a claims-made policy is limited. In order for coverage to apply, the policyholder must give notice of the claim within the policy period or any applicable extended period, as did the policyholder in Templo Fuente.

To avoid a forfeiture of coverage, policyholders should establish a protocol for giving notice of claims and potential claims under all potentially applicable insurance policies, including umbrella and excess policies. In Century Surety, the policyholder had notified the primary insurer but not the umbrella insurer, perhaps believing that the claim would not exceed the primary policy’s limits. The policyholder’s failure to notify the umbrella insurer did not forfeit coverage in that case, but would have under the no-prejudice rule.

Even If Insurer Has No Duty to Defend, It Could Have Duty to IndemnifyPaying attorneys’ fees and other costs of a defense against a third-party lawsuit can deal a tremendous blow to a policyholder’s bottom line. Not surprisingly, some of the hardest fought battles between policyholders and insurers center on whether insurers have a duty to defend. Because an insurer’s duty to defend is broader than its duty to indemnify, when a lower court rules that a particular insurer has no duty to defend, many policyholders walk away from their policies and look for other sources of recovery. A recent case demonstrates that policyholders should not let their insurers off the hook so easily.

In Hartford Casualty Insurance Company v. DP Engineering, L.L.C., the appeals court held that insurers might have a duty to indemnify even though they had no duty to defend. Entergy hired the policyholder engineering company to assist in removing and refurbishing a 520-ton component at a nuclear power plant. The gantry used to lift the component collapsed, killing one worker, injuring others, and causing “massive damage” to the plant. The insurers contended that they had no duty to defend or indemnify the policyholder in the multiple lawsuits that arose from the incident, based on the professional services exclusions in the policies. The district court agreed with the insurers.

The Fifth Circuit Court of Appeals disagreed with this line of reasoning. Even though the insurers had no duty to defend because the actions alleged in the complaints fell within the professional services exclusions, the court said, the insurer could still have a duty to indemnify. The insurers’ duty to indemnify could only be determined after a final adjudication of the lawsuits because the allegations did not “conclusively foreclose” the development of facts involving the insured’s non-professional services, which would trigger coverage under the policies.

This case is a reminder not to walk away from coverage in the face of a loss on the duty to defend. Policyholders pay premiums to secure both the duty to defend and the duty to indemnify, and should fight for both coverages to avoid responsibility for a settlement or judgment that could be as damaging to the bottom line as the costs of defense.

New York’s highest court recently ruled that a commercial general liability (CGL) policy’s additional insured provision, similar to ISO form no. CG 20 33 04 13, does not grant additional insured status to a third party not contracting directly with the named insured. The contract between the project owner and the subcontractor required the subcontractor to name the construction manager as an additional insured on the subcontractor’s CGL policy. Because the construction manager did not contract directly with the subcontractor, the court held that the construction manager was not an additional insured under the blanket “Additional Insured – By Written Contract” clause in the subcontractor’s CGL policy — even though the Certificate of Insurance (COI) identified the construction manager as an additional insured. The insurance policy, not the COI, controlled the insurance coverage.

This ruling highlights two important best practices. First, to provide additional insured coverage to a party with whom the named insured does not have a direct contract, the insurance policy should contain a blanket additional insured endorsement equivalent to ISO Form CG 20 38 04 13 (or a manuscript endorsement specifically naming the additional insured). ISO Form CG 20 38 04 13 provides additional insured coverage to a third party as long as the coverage is required in a written contract to which the named insured is a party. This endorsement does not require a direct written contract between the named insured and the additional insured. Second, an additional insured should not rely on a COI for coverage. When possible, the additional insured should obtain a complete copy of each insurance policy (including endorsements), or, at a minimum, a copy of the additional insured clause, to assess the available coverage.

What You Need to Know

  • If you do not contract directly with an entity required to name your company as an additional insured, you must ensure that the applicable insurance policy grants additional insured status without a written contract directly between the named insured and the proposed additional insured similar to ISO form CG 20 38 04 13.
  • A COI is not evidence of insurance coverage; the insurance policy controls the available coverage.
  • Obtain a copy of the insurance policy with all endorsements when expecting coverage as an additional insured to avoid unpleasant surprises later on. If you cannot obtain the entire insurance policy, seek a copy of the additional insured clause to assess the available coverage.

Summary of the Court’s Decision

In the New York case Gilbane Building Co./TDX Construction Corp., et al. v. St. Paul Fire and Marine Insurance Co., allegedly defective excavation work while building an addition to Bellevue Hospital in New York allegedly cause an adjacent building to sink and resulted in additional remediation costs and litigation against the subcontractor.

The subcontractor, Samson Construction Company (subcontractor), contracted with the project owner, Dormitory Authority of the State of New York (project owner), but not with the construction manager, Gilbane Building Co./TDX Construction Corp. (construction manager). The subcontractor agreed to name as additional insureds: “Dormitory Authority of the State of New York, The State of New York, the Construction Manager (if applicable) and other entities specified on the sample Certificate of Insurance provided by the Owner.”

The subcontractor procured a CGL policy that named as an additional insured “any person or organization with whom you [the insured] have agreed to add as an additional insured by written contract.” The COI named the construction manager as an additional insured: “The following are Additional Insureds under General Liability as respects to this project:  City of New York; City of New York Health & Hospital Corporation; Forensic Biology Laboratory; Dormitory Authority-State of New York; Gilbane/TDX Construction Joint Venture.”

The project owner sued the subcontractor and the project architect for the allegedly defective excavation, and the architect filed a third-party claim against the construction manager. The project owner notified the insurer of the claim approximately five months after suit was filed.

The construction manager sued the insurer for defense and indemnity. The insurer moved for summary judgment arguing that the construction manager did not qualify as an additional insured. The trial court denied the insurer’s motion because it found that the policy “requires only a written contract to which the Subcontractor is a party,” which was satisfied by the subcontractor’s contract with the project owner.

The appellate court reversed because the subcontractor did not contract directly with the construction manager as the subcontractor’s policy required. The court stated that “the ‘Additional Insured-By Written Contract’ clause of the [Insurer’s] policy clearly and unambiguously requires that the named insured execute a contract with the party seeking coverage as an additional insured. Since there is no dispute that the Subcontractor did not enter into a written contract with [the Construction Manager], the Subcontractor’s agreement in its contract with the Project Owner to procure coverage for [the Construction Manager] is insufficient to afford [the Construction Manager] coverage as an additional insured under the [Insurer’s] policy.” The court applied a “literal” application of the clause and required a contract directly between the construction manager and the subcontractor. Finding no contract, the court denied coverage to the construction manager.

To learn more about additional insured coverage, please check out our construction webinar series: Constructing the Best Coverage for You and Constructing the Best Coverage for Project Owners.