Court Prevents Insurer From Having Its Cake And Eating It Too

Insurers that breach their duty to defend argue frequently that they nonetheless have no duty to indemnify. They contend that while the breach of the duty to defend may subject insurers to liability for the costs incurred in defending the underlying actions, it does not subject insurers to liability for the amounts paid to resolve such actions. In so arguing, insurers seek to both breach their insurance policies, by breaching their duty to defend, and then rely on provisions of those breached insurance policies in disclaiming any duty to indemnify.

In an important victory for policyholders, generally, and Fried & Epstein’s client, Tate & Lyle North American Sugars, Inc., specifically, the Louisiana Court of Appeals prevented an insurer that was behaving in this manner from having its cake and eating it too. See Arceneaux v. Amstar Corp., et al., No. 2009-CA-0980 (La. Ct. App. 4th Cir. May 14, 2010). The Arceneaux Court held that an insurer could not avoid its duty to indemnify by enforcing the terms of its insurance policies that were breached when the insurer wrongfully refused to defend its policyholder.

The insurer, Continental Casualty Company had previously breached its duty to defend and had paid the substantial costs incurred by Tate & Lyle in defending against hundreds of underlying hearing loss claims. Continental argued nevertheless that its duty to indemnify was severely limited due to the application of certain policy provisions. In response, Fried & Epstein argued on behalf of Tate and Lyle that Continental could not enforce the terms of the very insurance policies that were breached when Continental wrongfully refused to defend.

In affirming the trial court’s grant of summary judgment to Tate & Lyle, the Court of Appeals found no error in the trial court’s conclusion that “Continental’s breach of the duty to defend Tate & Lyle is so grievous, mean spirited and designed to cause financial harm to [its] insured Tate & Lyle, [that] justice demands and [the court] must fashion a remedy for the redress of that breach which is commensurate with the breach of the duty to defend under [this] particular set of facts.”

Federal Court Diversity Jurisdiction: The Supreme Court Hits A “Nerve Center”

Insurance coverage cases are governed by state law. Nevertheless, those cases are often litigated in federal courts. Parties elect to proceed in federal court for various reasons. Insurance companies, fearing state court bias, often remove cases filed originally in state court to federal court. Policyholders may opt to file a case originally in federal court in the hope that the path to trial will be shorter.

In any event, proceeding in federal court requires diversity-of-citizenship. That is, each plaintiff must be a citizen of a state different from each defendant. If any plaintiff is a citizen of the same state as any defendant, then there is no diversity and the case may not proceed in federal court.

Determining the citizenship of an individual is straight forward and is guided by where one resides. Litigants and courts, however, often struggle when determining the citizenship of a corporation. The statute governing diversity jurisdiction provides that “a corporation shall be deemed a citizen of any state by which it has been incorporated and of the state where it has its principal place of business.” 28 U.S.C. § 1332(c)(1).

While determining the state of incorporation is easy, determining where a corporation maintains its “principal place of business” often proves difficult. When a corporation’s headquarters is located in the same state as its manufacturing plant and other centers of business, its principal place of business is within that state. The corporate citizenship determination is far more difficult when the corporate headquarters and other centers of business are located in different states.

In order to alleviate this confusion, the Supreme Court recently rendered an opinion adopting the “never center” approach to determining a corporation’s principal place of business. See Hertz Corp. v. Friend, __ U.S. __ (Feb. 23, 2010). Under that approach, the focus is on the place where “a corporation’s officers direct, control, and coordinate the corporation’s activities.” Slip op. at 14. In practice, this will be normally the place where the corporation maintains its headquarters. This assumes further that the corporate headquarters is the actual center of direction, control and coordination of corporate activities -- the “nerve center” if you will -- and not simply an office where the corporation holds its board meetings. Id.

Thus, for diversity purposes, a corporation is a citizen of any state in which it is incorporated and has its “nerve center.” Diversity will be present, and federal jurisdiction available, only if each plaintiff is the citizen of a state separate and distinct from each defendant.

Ten Tips to Securing Insurance Coverage for a Business Interruption

INTRODUCTION

In the aftermath of natural and man-made catastrophes like Hurricane Katrina and 9/11, insurance for business interruptions has taken on renewed importance.

Business interruption insurance is typically sold as an endorsement to first-party property insurance policies. It promises to indemnify policyholders for losses associated with insured interruptions of their business. As one court concluded, business interruption insurance “is designed to do for the insured . . . just what the business itself would have done if no interruption had occurred . . .” Eastern Associated Coal Corp. v. Aetna Cas. & Sur. Co., 632 F.2d 1068, 1079 (3d Cir. 1980).

As with any insurance claim, however, securing full and timely payment requires a special mix of perseverance and ingenuity. Following the steps outlined below can enhance your business interruption insurance recovery.

1. Locate the Implicated Insurance Policies:

Treatises have been written on the appropriate “trigger of coverage” in third-party liability cases. While less has been written on the “trigger of coverage” in the context of first-party property losses, the issue remains important.

Most often, a property loss is caused and becomes manifest at the same time, as in the cases of fires or explosions. Some property losses, however, may be caused by events that take place well in advance of when any damage becomes manifest. For example, property damage may commence upon the installation of a defective computer chip, even though damage to the computer may not become manifest for many years. In those circumstances, careful consideration should be given to whether insurance policies in force prior to any actual manifestation of damage are triggered.

Moreover, large losses may also trigger coverage under excess insurance policies.

2. Give Timely Notice:

As with any insurance claim, prompt and timely notice can only aid recovery efforts. Property insurance policies typically require the submission of a signed and sworn proof of loss within a very short time frame, such as ninety days. Insurance companies are usually amenable to extending this period of time, but it is a good practice to secure such extensions in writing.

In addition, property insurance policies also require the filing of suit against the insurance company within a certain period of time, typically one to two years after the date of loss. Failure to file suit within the prescribed time period may result in the forfeiture of insurance.

3. Minimize the Loss:

Property insurance policies typically require a policyholder to minimize the loss through mitigation efforts. In the context of a business interruption, policyholders should promptly: (a) make temporary repairs to damaged property and equipment; (b) incur those expenses that will expedite the end of the interruption; (c) secure alternate facilities or equipment; and (d) make use of available inventory. The unexcused failure to reasonably mitigate a loss could result in a loss of insurance.

Each of these activities should be undertaken in conjunction with the insurance company. Coordinating with, and seeking the assistance of, the insurance company will maximize the insurance recovery of these expediting and repair expenses. Obtaining the assistance of the insurance company makes sense for an additional reason -- they are, or should be, expert in such repair and recovery efforts.

4. Document the Loss:

The better and more completely that a policyholder can document its loss, the quicker and more fully will it secure an insurance recovery. Supporting documentation for the following is prudent, if not, essential: (a) the reconstruction schedule; (b) the experience of the business prior to the interruption; (c) the production and sales forecasts for the interruption period; (d) the experience of the business during the interruption period; (e) the net sales value of the products or services lost as a result of the interruption; (f) the variable costs associated with involved products or services; (g) the expenses incurred in mitigating the loss; and (h) the value of production or sales made up through the mitigation efforts.

A professional, such as an accountant or public adjuster, can be of immeasurable assistance in properly documenting a loss and preparing a business interruption claim. Often the fees charged by such professionals in providing claim documentation and preparation services are expressly covered under property insurance policies.

5. Determine the Period of Interruption:

Business interruption insurance policies insure losses occurring during a defined “period of interruption.” The “period of interruption” is typically defined to begin on the date when physical damage is sustained and end on the date when the damaged property could be repaired or replaced with due diligence or dispatch. As defined, the “period of interruption” refers to a “theoretical” period of time. The insurance industry desired the use of a theoretical period, because it:

wanted a standard of potential replacement time which was amenable to computation in advance and which was not subject to vagaries like owner indecision, strikes, or failure of lease negotiations which might affect the actual rebuilding time.

Beautytuft, Inc. v. Factory Ins. Assn., 431 F.2d 1122, 1125 (6th Cir. 1970).

Accordingly, the duration of any given “period of interruption” may be shorter or longer than the actual period of time it takes a policyholder to resume operations. No court, however, has found a period of interruption to be shorter than the actual repair or replacement time when a policyholder has acted diligently.

6. Determine the Loss Sustained:

The following multi-step formula serves as a useful guide in calculating a business interruption loss.

a. Determine the “period of interruption.”

b. Determine the quantity of lost production as reflected in inventory records, production records and sales records. Compute what the plant would have normally produced, had there been no loss, and then see how many units were actually produced. The difference is the gross lost production.

c. Deduct any sales or production that can be continued or made up through the use of existing inventory, the utilization of other plants, the utilization of overtime hours or other loss mitigation efforts. The difference is the net lost production.

d. Multiply the net lost production by the marginal value of a single production unit.

e. Add back the extra costs associated with replenishing inventory, and loss mitigation efforts.

The fundamental consideration in adjusting a business interruption loss is the actual experience of the policyholder’s business during the “period of interruption.” Business interruption policies typically provide, in a provision entitled “experience of the business,” that in determining the loss, "due consideration shall be given to the experience of the business before the date of damage . . . and to the probable experience thereafter, had the loss not occurred.

Accordingly, if a policyholder’s business would have operated at a loss during a period of interruption, it has been held that it suffers no compensable actual loss sustained. Berkeley Inn, Inc. v. Centennial Ins. Co., 422 A.2d 1078,1080 (Pa. Super 1980). On the other hand, a new business with no prior earnings can still collect under business interruption insurance, as long as it can demonstrate, through the use of accounting projections and other proofs, the requisite loss of profits during the period of interruption. Hutchings v. Caledonian Ins. Co. of Scotland, 52 F.2d 744 (E.D. SC 1931). Moreover, if a business’s earnings are reduced as a result of a planned maintenance shutdown or another non-insured event during the “period of interruption,” then the amount of actual loss sustained is reduced by a commensurate amount.

7. Seek Insurance Company Guidance on Non-covered Items or any Additionally Covered Items:

An insurance company’s obligation to adjust insurance claims fairly and in good faith requires that it advise its policyholder promptly of: (a) any claim which is, in whole or in part, potentially not covered; (b) any differences over loss measurement or valuation; and (c) any covered items that have been left out of the claim. Moreover, as discussed above, an insurance company should be made an integral part of any mitigation efforts. In that way, the insurance company may be barred from complaining later about reimbursing the costs of those efforts.

8. Submit the Claim:

An insurance “claim” or “proof of loss” is a submission by a policyholder to the insurance company, which states and documents the amount of the policyholder’s loss. It should be signed by an authorized representative of the policyholder and state the date and location of the loss as well as the amount claimed. With respect to a business interruption, it should summarize the claim components discussed above, including; (a) the period of interruption; (b) the production lost as result of the interruption; (c) the value of that lost production; and (d) the expenses incurred in mitigating the loss. The claim should also include all of the documentation supporting the claim components and values.

9. Seek Advances of Undisputed Portion of Claims:

Insurance companies will advance their policyholders’ payments for those portions of an insurance claim over which there is no dispute. Accordingly, even if there is a dispute over a portion of a claim, press for payment of the undisputed portion. By pressing for and receiving advances, the insurance company may be precluded from using those funds as leverage for resolving the disputed portion of the claim to its advantage.

10. Be Prepared to Appraise, Arbitrate and Litigate:

At times, the only way to secure a reasonable insurance recovery is to resort to some type of dispute resolution mechanism. The better prepared you are for that possibility, the more positive the outcome will be. By following the steps outlined above, you will be prepared to present your claim almost immediately to the arbiter, whether it be a judge, jury, arbitrator or appraiser.

Although property insurance policies typically contain appraisal clauses, appraisal is not appropriate in all circumstances. Rather, appraisal is appropriate only in disputes over the amount or value of a loss. Legal disputes, including policy interpretation issues, are typically not subject to appraisal.

Should litigation become necessary, make certain to select the most appropriate forum in which to litigate. Insurance law issues are governed by state law, which can vary dramatically on a state by state basis. To the extent that a choice is available, make sure you choose the most advantageous forum.

CONCLUSION

Like most important business matters, securing a full insurance recovery in response to a business interruption requires careful planning, the collection and presentation of detailed records, an awareness claim submission deadlines and requirements and the guidance of experienced professionals. Adherence to above-described steps should expedite and enhance any insurance recovery.

Three's A Crowd: Adventures In The Tripartite Relationship

An insurance company’s duty to defend its policyholder is at least as important as its duty to indemnify -- if not more so. Indeed, it has been estimated that 55 cents out of every claim dollar is paid for defense.

The not insignificant expense associated with defending claims has caused insurers to seek greater control over the defense of claims asserted against policyholders. With increasing frequency, insurers are insisting on the use of panel defense counsel, the adherence to strict billing guidelines and the pre-approval of even the most basic costs. The resulting tensions have led defense counsel to seek guidance from their bar associations and policyholders to seek relief from the courts. Those tensions are exacerbated even further when conflicts of interest between insurers and policyholders arise.

This article discusses the nuances of the tripartite relationship involving insurers, policyholders and defense counsel and examines the current state of the law governing that relationship.

I. The Policyholder Is Always The Client

Even when an insurer is defending an action without reservation, the policyholder remains the client of the defense counsel retained and paid by the insurer. In certain jurisdictions, however, the insurer is also considered the client when a tripartite relationship is formed. Notwithstanding whether the insurer is also considered the client, insurers will invariably insist that they are entitled to control that defense, especially when they are defending without reservation.

According to insurers, the right to control will include the right to select defense counsel, approve all tactical decisions and settle any claim within policy limits. At times, however, the policyholder and insurer may have divergent views on how to defend a case or the policyholder may have business reasons for not wanting to settle a case within policy limits. In those situations, the Model Rules of Professional Conduct for attorneys provide necessary guidance for defense counsel and their clients.

Rule 1.2(a) of the Model Rules dictates that the lawyer must consult with and abide by a client’s decisions concerning the representation. Moreover, Model Rule 5.4(c) provides that a lawyer “shall not permit a person who recommends, employs or pays a lawyer to render legal services for another to direct or regulate the lawyer’s professional judgment in rendering . . . legal services.” Thus, irrespective of whether the insurer is also deemed the client, defense counsel must consult with the policyholder, and not permit the insurer to interfere with counsel’s judgment in defending the interests of the policyholder.

II. An Insurer May Not Insist On Unfettered
Compliance With Its Billing Guidelines

In an effort to reduce litigation costs, insurers are increasingly insisting that defense counsel comply with stringent billing guidelines. Those guidelines typically impose strict reporting requirements and require defense counsel to seek prior insurer approval of any significant costs to be incurred. The insurer’s interest in reducing costs will, in many instances, diverge from the policyholder’s interests in obtaining the best possible defense.

When compliance with insurer-imposed billing guidelines will compromise the defense, defense counsel must protect the policyholder’s interests. In those circumstances, defense counsel must first consult with both the insurer and the policyholder. If the insurer is unwilling to modify or withdraw the limitation a billing guideline places on the defense, and the policyholder is unwilling to accept that limitation, Rule 1.7(b) requires that defense counsel withdraw from representation of both the policyholder and the insurer. Rule 1.7(b) provides, in pertinent part, that “[a] lawyer shall not represent a client if the representation of that client will be materially limited by the lawyer’s responsibilities to another client or to a third person . . . .”

A specific cost-reduction mechanism employed by insurers, which has come under fire recently, is the use of third-party auditors to review defense counsel bills. Such “legal bill audits,” typically involve an examination of hourly rates charged, time spent and defense counsel’s work product to determine the reasonableness of the amounts charged.
In the usual case, defense counsel may share this type of information with the insurer because such sharing is either required by the insurance policy or it is permissible in those jurisdictions in which the insurer is also considered the client of defense counsel. When the disclosure would affect a material interest of the policyholder, however, defense counsel may not share such information with the insurer, absent informed consent from the policyholder. For example, defense counsel are usually prohibited from disclosing information to the insurer that could adversely affect the policyholder’s coverage under the insurance policy at issue. An apt example was provided by the Pennsylvania Bar Association:

Generally, an attorney representing an insured need only inform the Insurer of the information necessary to evaluate a claim. For example, assume an attorney represents an Insured in a premise liability slip and fall. During the course of the representation, the attorney discovers that the subject property is a rental property, not a residential property as set forth in the policy.

Although this information may radically affect coverage, the attorney is prohibited from releasing this information to the Insurer or any other third parties. In the foregoing hypothetical, the attorney would simply inform the Insurer of the nature of the injuries claimed by plaintiff and the circumstances surrounding the incident. The insurer would have all of the information necessary to evaluate the value and basis for the claim and the Insured’s confidentiality would be protected.

Pa. Bar Assoc. Comm. On Legal Ethics and Prof. Resp. Informal Op., No. 97-119, 1997 WL 816708 at *2 (Oct. 7, 1997).

Moreover, the majority of jurisdictions have concluded that defense counsel may not disclose confidential information to a third-party auditor, absent the policyholder’s informed consent. Unlike the case with insurers, disclosure of such information to third-party auditors, with whom defense counsel have no employment or contractual relationship, may result in a waiver of any applicable privilege. In order to secure informed consent from the policyholder, defense counsel must discuss the nature of the disclosures sought by the third-party auditor as well as the consequences of disclosure (i.e., potential waiver of privilege) and non-disclosure (i.e., insurer may view non-disclosure as a breach of the duty to cooperate under the insurance policy).

III. When Conflicts Arise, The Insurer Must
Relinquish Control Over The Defense

When a conflict of interest between the insurer and policyholder arises, an insurer must typically relinquish any right to control the defense, including the right to select defense counsel. “It is settled law that where conflicts of interest between an insurer and policyholder arise, such that a question as to the loyalty of the insurer’s counsel to that policyholder is raised, the policyholder is entitled to select its counsel, whose reasonable fee is to be paid by the insurer.” St. Peter’s Church v. American Nat. Fire Ins. Co., No. 00-2806, 2002 WL 59333 at *10 (E.D. Pa. Jan 14, 2002).

A classic example of a conflict necessitating the retention of independent counsel may arise where the insurer reserves the right to deny coverage for certain of the underlying claims, but not others. In that situation, an insurer “would be tempted to construct a defense which would place any damage award outside policy coverage.” Public Serv. Mut. Ins. Co. v. Goldfarb, 442 N.Y.S.2d 422, 427 (N.Y. 1981).

Another prime example of a conflict sufficient to cause an insurer to relinquish the control over the defense is where the insurer lacks the economic motive for mounting a vigorous defense. This situation may arise where the underlying claimant prays for damages that are well in excess of the insurer’s policy limits. See, e.g., Emons Indus., Inc. v. Liberty Mut. Ins. Co., 749 F. Supp. 1289, 1297 (S.D.N.Y. 1990).

IV. Conclusion

The tripartite relationship between the insurer, policyholder and defense counsel provides fertile ground for confusion and abuse. Even when an insurer defends a matter without reservation, the policyholder remains the client and can properly object to any limitations placed on the defense by the insurer. If defense counsel reasonably believes that an insurer-imposed limitation will materially impair the defense, defense counsel must withdraw from representing both the insurer and the policyholder.

When a conflict of interest between the insurer and policyholder arises, the insurer must relinquish control over the defense and the policyholder is entitled to select defense counsel. Such a conflict may arise where an insurer reserves the right to deny coverage for only certain of the underlying claims, or where the insurer does not have an economic incentive to defend vigorously, or where the insurer could construct a defense placing any damage award outside of coverage.

Into The Breach: Insurance Coverage For Breach Of Contract Claims

If asked, most insurance professionals would say that general liability insurance policies do not cover breach of contract claims. Indeed, numerous courts have held that general liability policies cover only tort liabilities. See, e.g., Windt, Insurance Claims and Disputes, § 11.7, n.2. Those courts premise their holdings on either the insuring agreement (which promises to pay on behalf of an insured all sums the insured becomes “legally obligated to pay as damages”) or the definition of “occurrence” (which is defined, in part, as an “accident”).

This issue arises most commonly in connection with product and work-related claims. In that context, underlying claimants typically assert a broad range of claims for breach of contract, breach of warranty and negligence. Increasingly, insurers deny coverage for such claims by contending that the “gist” of such actions are for breach of contract, which are not covered by their general liability policies. Such denials of coverage, however, are not supported by the language of the policies.

There is nothing in the phrase “legally obligated to pay as damages” that would exclude coverage for breach of contract claims. As cogently explained by the California Supreme Court:

“The expression ‘legally obligated’ connotes legal responsibility that is broad in scope. It is directed at civil liability….[which] can arise from either unintentional (negligent) or intentional tort, under common law, statute, or contract.” (Malecki & Flitner, Commercial General Liability (6th ed. 197) p. 6, italics added.) “The coverage agreement [which] embraces ‘all sums which the insured shall become legally obligated to pay as damages….’ … is intentionally broad enough to include the insured’s obligation to pay damages for breach of contract as well as for tort, within limitations imposed by other terms of the coverage agreement (e.g. bodily injury and property damage as defined, caused by an occurrence) and by the exclusions….” (Tinker, Comprehensive General Liability Insurance-Perspective and Overview (1975) 25 Fed. Ins. Counsel Q. 217, 265).

Vandenberg v. Superior Court, 982 P.2d 229, 245-46 (Cal. 1999) (alterations in original).

Moreover, the definition of “occurrence” does not necessarily preclude coverage for breach of contract. An “accident” is defined as “[a]n unexpected and undesirable” event or “something that occurs unexpectedly or unintentionally.” Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co. , 908 A.2d 888, 897-98 (Pa. 2006) (quoting Webster’s II New College Dictionary 6 (2001). Here again, there is nothing to alert the policyholder that breach of contract claims are not covered.

In contrast to the lack of specific language precluding coverage for breach of contract and warranty claims, general liability policies typically contain language indicating that such coverage is intended. First, general liability policies provide specific coverage for liabilities resulting from the breach of warranties. The Products/Completed Operations Hazard of general liability policies provides specific coverage for liabilities arising out of a policyholder’s “product” and/or “work.” The policyholder’s “product” and “work” are, in turn, defined to include any “[w]arranties or representations made at any time with respect to the fitness, quality, durability, performance or use of” the policyholder’s product or work.

Second, general liability insurance policies contain numerous exclusions for claims arising from breach of contract. “Exclusions, by their very nature, are designed to operate to deny coverage that otherwise would be provided under the definition of an occurrence.” Donegal Mut. Ins. Co. v. Baumhammers, 893 A.2d 797, 819 (Pa. Super. 2006). There would be no need for these breach of contract exclusions if such claims were not covered in the first instance.

In determining whether claims arising from a policyholder’s product or work are covered, the better reasoned decisions do not focus on the contract/tort distinction. As explained by the California Supreme Court, “[c]overage under a CGL insurance policy is not based upon the fortuity of the form of action chosen by the injured party.” See, e.g., Vandenberg, 982 P.2d at 243. Rather, the better reasoned decisions focus on the nature of the damage, the insured risk and the specific policy language. Imperial Cas. and Indem. Co. v. High Concrete Structures, Inc., 858 F.2d 128, 134, n.7 (3d Cir. 1988). In the words of the Third Circuit: “What is at issue here, however, is not the distinction between tort and contract liability but a specific insurance contract that must be interpreted according to well-established rules of construction.”

Coverage should be found when the policyholder’s product or work causes harm to the person or the property of another. This point was best stated by the Supreme Court of Nebraska:
“[A]lthough a standard CGL policy does not provide coverage for faulty workmanship that damages only the resulting work product, if faulty workmanship causes bodily injury or property damage to something other than the insured’s work product, an unintended and unexpected event has occurred, and coverage exists.” Auto-Owners Ins. Co. v. Home Pride Cos., Inc., 684 N.W.2d 571, 578 (Neb. 2004) (citations omitted).

In the end, the proper focus in determining coverage should be on the nature of the injury alleged and not on the claimant’s cause of action. To the extent the policyholder’s product or work cause harm to the person or property of another, coverage should exist, irrespective of the claimant’s choice of cause of action.

Lawyers Are Policyholders (People) Too

In a decision that is sure to warm the hearts of our attorney friends and colleagues, the New York Appellate Division held in favor of our client and attorney in the case of American Guaranty and Liability Insurance Company v. Moskowitz, 870 N.Y.S.2d 307 (App. Div. 1st Dep’t, Jan 6, 2009) (“American Guaranty”). The American Guaranty case involved insurance under a legal liability policy for claims after our client was drawn into litigation filed initially against one of his law firm’s clients. Conopco, Inc. d/b/a/ v. Dina Wein, et al., Civil Action No. 05-CV-9899 (S.D.N.Y.) (“Conopco”). The plaintiffs in Conopco asserted claims for, among other things, RICO violations and fraud.

The insurer, after agreeing initially to defend, denied coverage and filed an action seeking a declaration that it had neither a duty to defend nor indemnify. To make matters worse, the insurer also sought reimbursement of the amounts it had already expended in our client’s defense.

In response to our client’s motion to dismiss, the Magistrate Judge in the underlying Conopco case recommended dismissal, without leave to re-plead, of all claims against our client for failure to state a cause of action. Thereafter, the Conopco plaintiffs dismissed all such claims with prejudice. Notwithstanding the complete exoneration of our client, the insurer continued to insist that it owed no duty to defend and was entitled to reimbursement of all costs expended in our client’s defense.

In response to the parties’ cross-motions for summary judgment, the trial court in the insurance coverage action held entirely in our client’s favor. Not only did that court hold that the insurer had a duty to defend, it also held that our client was entitled to reimbursement of all costs expended in defending against both the underlying Conopco Action as well as the insurance coverage action. Those holdings were thereafter affirmed in their entirety by the Appellate Division.

The holdings in American Guaranty, in and of themselves, are unremarkable. In finding a duty to defend on American Guaranty’s part, the courts applied the nearly universal rule that requires an insurer to defend whenever the allegations of the underlying complaint “suggest [a] reasonable possibility of coverage….” American Guaranty, 870 N.Y.S.2d at 308 (quoting Automobile Ins. Co. of Hartford v. Cook, 7 N.Y.3d 131, 137 (2006)). Likewise, a policyholder in New York is entitled to recover the costs of defending against its insurer’s declaratory judgment action. See U.S. Underwriters Ins. Co v. City Club Hotel, LLC, 3 N.Y.3d 592 (2004); Mighty Midgets, Inc. v. Centennial Ins. Co., 47 N.Y.2d 12 (1979).

What is remarkable and troubling is the aggressive stand that the insurer took in response to a claim by an attorney who was in a better position than most to protect his rights. In light of the failing economy and the already increased pressure on insurance company profits, tactics like these can be expected to increase, especially in connection with less sophisticated policyholders. As always, vigilance, persistence and occasionally litigation are the best defense to an insurer’s wrongful denial of claims.

On the Defensive: Excess Insurers And The Duty To Defend

When one thinks of excess insurance (and who doesn’t) the duty to defend is probably not the first thing that crosses the mind. The duty to defend is typically associated with primary insurance, not excess insurance that provides coverage above underlying layers of primary or other excess insurance. Not all excess insurance is the same, however, and certain excess insurance policies, especially excess umbrella insurance policies, expressly impose a duty to defend on the excess insurer.

Umbrella insurance policies have been referred to as “hybrid” policies because an umbrella policy “combines the characteristics of both a primary and a following form excess policy.” An umbrella insurance policy typically promises to defend occurrences covered by the terms of the umbrella policy, but not the underlying primary policy. That duty to defend is set forth in the Defense Settlement provision of certain umbrella policies.

Beyond defense coverage for occurrences not covered by underlying insurance, some umbrella insurance policies also promise to defend the policyholder upon the exhaustion of underlying insurance. Courts have focused on three policy provisions in determining that umbrella excess insurers have such a duty to defend: (1) Underlying Insurance; (2) Retained Limit-Limit of Liability; and (3) Assistance and Cooperation.

Starting with the last provision first, an Assistance and Cooperation provision in an excess insurance policy with no duty to defend will typically provide that the insurer “shall not be called upon to assume charge of the settlement or defense of any claim, suit or proceeding….” Assistance and Cooperation clauses in umbrella policies that include a duty to defend provide differently, as follows:

Except as provided in Insuring Agreement II (Defense, Settlement) or in Insurance Agreement VI (Retained Limit-Limit of Liability) with respect to the exhaustion of the aggregate limits of underlying policies listed in Schedule A, or in Condition J [Underlying Insurance] the company shall not be called upon to assume charge of the settlement or defense of any claim made or proceeding instituted against the insured; but the company shall have the right and opportunity to associate with the insured in the defense and control of any claim or proceeding reasonably likely to involve the company. In such event the insured and the company shall cooperate fully.

Thus, pursuant to this form of the Assistance and Cooperation clause, the insurer is obliged to defend pursuant to the three provisions identified in the clause. As discussed above, the Defense Settlement provision requires the umbrella insurer to defend claims covered by the umbrella policy, but not the underlying insurance policy. Pursuant to the remaining two provisions, the umbrella insurer is obliged to defend upon the exhaustion of underlying insurance.

As for the effect of the Underlying Insurance provision, one court concluded that the plain terms of the provision imposed defense obligations:

"All three policies contain a clause imposing an obligation to assume charge of and pay for [the policyholder’s] defense under certain circumstances. Specifically, [the Underlying Insurance provision of] the policies provide:

If underlying insurance is exhausted by any occurrence, [the Excess Insurer] shall be obligated to assume charge of the settlement or defense of any claim or proceedings against the insured resulting from the same occurrence, but only where this policy applies immediately in excess of such underlying insurance without the intervention of excess insurance of another carrier.

Accordingly, by its plain terms, the policies impose defense obligations upon the insurers where the immediately underlying insurance has been exhausted by a single occurrence."

The Eighth Circuit Court of Appeals also relied on the Underlying Insurance provision in concluding that the insurance policy expressly imposed defense obligations on the insurer.

The Retained Limit-Limit of Liability provision provides, in pertinent part, that the excess policy “shall continue in force as underlying insurance,” in the event of “exhaustion” of the aggregate limits of liability of the underlying policies. In accordance with this language, an excess insurer must function as a primary insurer upon exhaustion of the underlying primary policy. Of course, functioning as a primary insurer includes the assumption of the duty to defend that was previously shouldered by the primary insurance before the exhaustion of the primary policy.

Accordingly, it would be a mistake to blindly assume that an excess insurance policy contains only a duty to indemnify, and no duty to defend. As always, the policy language controls, and policyholders should not hesitate to take advantage of all of the benefits the duty to defend offers.