Fourth Circuit Rules That Separation of Insureds Clause Does Not Prevent Intent From Being Imputed to Insured Principal

The Fourth Circuit Court of Appeals recently held that an insurer had no duty to defend the insured university in a suit by a mother alleging that the university and its employees participated in kidnapping her daughter. The court ruled that the policy’s “Separation of Insureds” clause did not prevent the intent of the university’s agents from being imputed to the university. Liberty University Inc. v. Citizens Ins. Co. of America et al., No. 14-2254, 2015 U.S. App. LEXIS 11888 (4th Cir. Va. July 10, 2015).

In a unique, complex and rather disturbing set of facts, the underlying plaintiff sued Liberty University and numerous individuals involved in the alleged kidnapping of the her daughter. The University, certain employees and various affiliated entities allegedly conspired with the plaintiff’s former domestic partner to violate court-ordered custody and visitation orders to prevent the plaintiff from having contact with the couple’s young daughter. In her suit against the university and its employees, the plaintiff alleged that the university “was directly liable for conspiring to ‘commit the intentional tort of kidnapping’” and violating RICO by “conspiring ‘through [a] pattern of racketeering’ to kidnap the child.’” Id. at 4. The plaintiff also alleged that the university was vicariously liable for its agents’ racketeering, participation in kidnapping and conspiring to violate the plaintiff’s parent-child relationship. Id. at 5. Specifically, the plaintiff contended that the university’s law school dean and professor assisted the partner in violating court orders and solicited donations to help her abscond to Nicaragua with the child. Id. at 5. A law school employee also allegedly had her father drive the partner and child to the Canadian border in disguise, using university phone lines. Id. at 6.

After the insurer refused to defend the underlying lawsuit, the university sought declaratory judgment. The United States District Court for the Western District of Virginia found for the university on summary judgment. Id. at 11. The liability policy at issue covered occurrences and suits alleging personal and advertising injury. It had exclusions for expected or intended injuries, criminal acts and knowing violations of others’ rights. Id. at 7-10. Critically, the policy also contained a separation of insureds clause, which bound the insurer “to evaluate the claims against each named insured individually…so that excluded conduct by one insured does not preclude claims brought by other insureds.” Id. at 10-11.

The district court ruled that the separation of insureds clause “forbade the court from imputing to [the university] the intent of its agents.” Id. at 13. The court determined that under the clause, it was required to separate the intent of the university from those of its individual agents. Id. at 12. Here, the district court focused on the fact that the underlying complaint did not allege that the university “individually expected or intended the alleged kidnapping.” Id. at 13. The district court also held that the complaint did not “sufficiently allege” the university’s vicarious liability, providing “only conclusory allegations that tie [the university] to the actions of its alleged agents and employees.” Id. at 14.

The Fourth Circuit Court of Appeals disagreed and reversed, based largely on its different reading of the separation of insureds clause. The clause did not “displace Virginia’s rule that an agent’s intentionally tortious act cannot be ‘unexpected’ by the principal who is vicariously liable for the act.” Id. at 19-20. There was “ample reason” to anticipate that Virginia would impute the intent of the university’s agents to the university. Id. at 20. Also, one such agent who acted with intent (the law school employee) was a named defendant. Id. Because she was either an employee or volunteer worker under the policy, she “would qualify as a named insured” such that the university was not “the only insured requesting a defense under the policy.” Id. at 20. Further, the complaint explicitly alleged that the university was “directly liable for harm arising from its intentional participation in conspiracies and vicariously liable for the intentional acts of its agents.” Id. at 24. In other words, the complaint did not allege the university’s liability for its agents’ intentional acts on a negligence theory. Id. at 22-24. The court thereby found that the separation of insureds clause “unambiguously would not displace the ordinary rule …that a complaint alleging a principal’s liability solely in respondeat superior for the acts of its agent does not state an ‘occurrence.’” Id. at 24. In addition, the court found the clause unambiguous and that even if it were ambiguous, the court could not “entertain an absurd result” and enlarge coverage. Id. Lastly, the court determined that the complaint “clearly” demonstrated the university’s respondeat superior liability beyond “conclusory allegations,” since it alleged facts and circumstances demonstrating the law school employee’s role in kidnapping and racketeering. Id. at 27.

Liberty prompts us to scrutinize separation of insureds clauses, both in drafting and litigation. Drafters must think ahead to how policyholders may try to appropriate these provisions to establish or extend coverage in the absence of valid claims. In litigation, insurers may benefit from proactively establishing that the clause does not serve as a shield to insured principals.

Under Illinois Law, Nontrivial Possibility of Excess Judgment Creates Conflict Requiring Independent Defense Counsel

In Perma-Pipe, Inc. v. Liberty Surplus Insurance Corp., No. 13-2989, 2014 U.S. Dist. LEXIS 54867 (N.D. Ill. April 21, 2014), the Northern District of Illinois held an insurer breached its duty to defend when it refused to pay for the insured’s independent defense counsel. Although the insurer had waived all coverage defenses, there was a “nontrivial” exposure over the policy limit, which created a conflict of interest under Illinois law.

The insured, Perma-Pipe, was a pipe manufacturer sued for alleged “catastrophic” pipe failures with damages alleged over $40 million.   Liberty issued a commercial general liability (CGL) policy with $1 million per occurrence and $2 million aggregate limits.  Liberty agreed to defend, but reserved rights and allowed Perma-Pipe to select independent defense counsel.  Liberty later withdrew its reservations and retained its own defense counsel. Perma-Pipe sued.

The federal district court, applying Illinois law, found a conflict of interest requiring independent defense counsel.  Because Perma-Pipe was sued for more than $40 million, far above the policy limits, there was “a nontrivial probability” of an excess judgment. While Liberty argued Perma-Pipe had excess coverage, there was no evidence of this in the record.  In any event, the possible existence of excess coverage would not negate the conflict.

While the “nontrivial” excess exposure test may be difficult to apply, that is apparently not the case where the exposure alleged dwarfs the available coverage limits.

Delinquent Claims Are Timely Claims: Eighth Circuit Declares Notice Provision Ambiguous

In George K. Baum & Co. v. Twin City Fire Insurance Co., No. 12-3982 (8th Cir. July 16, 2014), the Eighth U.S. Circuit Court of Appeals ruled that the “as soon as practicable” notice language in a claims made professional services policy was ambiguous, rejecting the insurer’s late notice defense.

The insured, a municipal bonds dealer, secured professional services insurance from Twin City for a policy period from 2003 to 2004.  In 2003, the Internal Revenue Service opened an investigation based on the insured’s faulty representation that interest on the municipal bonds was tax exempt.  The insured notified its insurer of actual claims by the IRS and future potential claims by the insured’s municipal clients.  The insurer treated the IRS investigation as a claim under the policy and the insured ultimately settled with the IRS for $7.7 million without admitting misconduct.  In 2008, two years after settling with the IRS, various municipalities filed derivative suits against the insured, which were consolidated into an MDL in Southern District of New York.  The insured did not notify Twin City of the litigation until 2010, another two years later.

The insurer initially denied coverage on the basis that the derivatives claims were not claims made during the 2003-2004 policy period, but it later withdrew its position because the claims related back to the timely-reported IRS investigation.  The insurer also denied coverage based on late notice, arguing that under New York law, it did not have to prove prejudice.

The U.S. District Court for the Western District of Missouri ruled that Missouri law applied and that the insurer could not prove the prejudice required to deny coverage based on late notice.  The Eighth Circuit Court of Appeals affirmed rejection of the late notice defense, but on different grounds.   The court first ruled that New York law applied because the policy was issued to the insured’s office in New York specifically to avoid paying Missouri’s surplus lines tax.  Although the insurer was correct that it was not required to prove prejudice under New York law, the court found that the policy’s notice requirement was ambiguous.

The policy’s insuring agreement required notice “as soon as practicable, but in no event later than sixty (60) days after the POLICY EXPIRATION DATE” in 2004.  The policy also provided that “all claims based upon, or arising out of, the same wrongful act or interrelated wrongful acts shall be considered a single claim for all purposes…which shall be deemed first made at the time the earliest of all such claims was first made.” Thus, the court concluded that the subsequent multi-district litigation “constitute[d] ‘a single claim for all purposes,’ including notice” that was provided in 2003.  The court also found that the “as soon as practicable requirement” was ambiguous when considered in conjunction with the 60-day time limitation and the relation back language.  Finally, the court rejected the insurer’s alternative argument that the insured’s interpretation would allow it “to wait weeks, months or even years” before providing notice. The court was unpersuaded by “the complaints of a poor draftsman” and it warned that it would not “rescue an insurer from its own drafting decisions.”

Baum reminds us that courts continue to construe notice provisions generously in the insured’s favor and encourages a vigilant approach both to drafting and to litigation strategy regarding how that drafting might be later perceived by a court.