Insurer Barred From Contesting Coverage Due to Generic Reservation of Rights Letter

In an opinion filed January 11, 2017, the South Carolina Supreme Court held that an insurer’s reservation of rights must contain more than verbatim recitation of policy provisions to properly reserve its right to later dispute coverage. Harleysville Group Insurance v. Heritage Communities, Inc., et al., 2017 S.C. LEXIS 8 (Jan. 11, 2017). The state supreme court also upheld a pro rata allocation of progressive damages under a time-on-risk analysis, and rejected the argument that punitive damages were subject to the time-on-risk allocation. The decision emphasizes the importance of drafting reservations of rights specific to the facts of the case, and informing the insured of why certain provisions may limit coverage under the facts of the case.

The coverage action arose out of two underlying construction defect actions. Harleysville Group Insurance (“Harleysville”) insured related corporate entities that developed and constructed two separate condominium complexes (collectively referred to as “Heritage”), who were sued for damages arising out of alleged construction defects, including significant water intrusion damages. Harleysville agreed to defend under a reservation of rights and retained defense counsel. After verdicts against Heritage for actual and punitive damages were rendered, Harleysville filed a declaratory relief action to determine the amount of covered damages. The matter came before the state supreme court after certification by the court of appeals.

The court first addressed the adequacy of Harleysville reservation of rights, and concluded that the letters were not specific enough to contest coverage. Although Harleysville had quoted policy language verbatim in its initial reservation of rights, the court found that – except with regard to punitive damages – the letters failed to explain how specific policy provisions might preclude coverage and, to the extent exclusions may apply, did not inform the insured that Harleysville may seek declaratory judgment to allocate between covered and non-covered damages. As a result, Harleysville was precluded from raising coverage defenses regarding compensatory damages.

Although the court found Harleysville had properly reserved its rights regarding punitive damages, neither the policy’s insuring agreement nor its “expected or intended” exclusion applied to preclude coverage for punitive damages. According to the court, absent explicit language that excluded coverage for punitive damages, the insuring agreement could not be construed as limiting coverage to compensatory damages only. Regarding the exclusion, the court found Harleysville failed to meet its burden that Heritage acted intentionally and intended the specific type of loss or injury.

Finally, with regard to the compensatory damage award, the court upheld a pro rata allocation of the progressive damage. Because some definable portion of the damage in the underlying cases was unrelated to an injury during the policy period, a progressive damages analysis was proper for the compensatory damages, but not the punitive damage award.

There are various takeaways from this decision, but the most concerning is that the South Carolina Supreme Court expanded the scope of coverage beyond that provided by the policy because it found that the insurer did not properly reserve rights. To avoid such an absurd result, and to properly preserve coverage defenses, insurers should revisit the use of generic or form reservation of rights letters, and consider updating the reservation of rights letter during the life of the underlying case if certain provisions appear to be particularly relevant.

Cumis Counsel Rule Adopted by Nevada Supreme Court

In response to certified questions from the U.S. District Court for the District of Nevada, the Nevada Supreme Court has adopted the Cumis independent counsel rule established by California courts requiring an insurer to provide independent counsel for its insured when a conflict of interest arises between the insurer and insured. State Farm Mut. Auto Ins. Co. v. Hansen, 131 Nev. Adv. Op. 74 (Sept. 24, 2015). The court also rejected application of a standard that creates a per se conflict of interest to every case in which there is a reservation of rights. Instead, Nevada courts must ask, on a case-by-case basis, whether an actual conflict exists.

In the underlying litigation, State Farm’s insured was sued for negligence and various intentional torts following an altercation at a house party and subsequent auto collision. State Farm agreed to defend under a reservation of rights, but did not agree to provide independent counsel to its insured. In subsequent coverage litigation, the federal district court initially found that State Farm breached its contractual duty to defend because it had not provided independent counsel to its insured.  The court then reconsidered and asked the Nevada Supreme Court to resolve questions concerning the state’s conflict of interest rules in insurance litigation.

Recognizing that Nevada, like California, is a dual-representation state – meaning that insurer appointed counsel represents both the insurer and insured – the Nevada Supreme court held that “counsel may not represent both the insurer and the insured when their interests conflict and no special exception applies.” This justified application of the Cumis rule in Nevada.

The Court then considered what circumstances created a conflict of interest and, in particular, whether a reservation of rights created a per se right to independent counsel. The Court concluded that even when there is a reservation of rights and insurer-appointed counsel has control over an issue in the case that will also decide the coverage issue, courts must still determine whether there is an actual conflict of interest. Relying on Nevada’s Rule of Professional Conduct 1.7, the Court explained, “[t]his means that there is no conflict if the reservation of rights is based on coverage issues that are only extrinsic or ancillary to the issues actually litigated in the underlying action.”

The decision provides useful guidance to Nevada litigants and trial courts for resolving conflict of interests in insurance litigation. However, the opinion leaves unaddressed other Cumis-type issues such as the reasonable amount of fees for independent defense counsel. As such, more litigation and possible legislation to clarify the rule should be expected.

Pennsylvania High Court Allows Policyholder to Recover Voluntary Settlements Paid without Insurer Consent Even Absent Insurer Bad Faith

On July 21, 2015 a sharply divided (and short-handed) Pennsylvania Supreme Court ruled 3-2 that an insurer defending an insured subject to a reservation of rights may be required to reimburse its insured for any “fair and reasonable” settlement its insured enters into even when the insurer does not consent to the settlement, and even where the insurer has not acted in bad faith. Babcock & Wilcox Co., et al. v. American Nuclear Insurers, et al., 2015 Pa. LEXIS 1551, No. 2 WAP 2014. The Court, however, did not give carte blanche to insureds to settle without insurer consent. Instead, the Court held that such a right is “limited to those cases where an insured accepts a settlement offer after an insurer breaches its duty by refusing the fair and reasonable settlement while maintaining its reservation of rights and, thus, subjects an insured to potential responsibility for the judgment in a case where the policy is ultimately deemed to cover the relevant claims.” In other words, the Court held that an insurer defending under a reservation of rights either must (1) consent to and pay a fair and reasonable settlement offer presented to its insured, (2) withdraw any reservation of rights, or (3) risk having to reimburse its insured who settles without consent if the claim is found to have been covered under the policy. As the dissent emphasized, the Court’s ruling represents a substantial abrogation of the contractual rights of insurers under Pennsylvania law, which previously permitted policyholders to circumvent the “voluntary payments” provisions of typical liability policies only where their insurers were guilty of having acted in bad faith conduct in failing to settle the underlying claim.

Babcock & Wilcox (“B&W”), along with ARCO, had been sued in a long-running class action involving over 500 plaintiffs claiming bodily injury and property damage from alleged emissions from the defendants’ nuclear faculties. B&W’s insurer, ANI, had provided an aggressive defense, subject to a reservation of rights, expending more than $40 million over the course of two decades, pursuant to a policy with $320 million in limits (which were eroded by defense costs). The policy contained a standard consent to settlement/cooperation clause that provided, inter alia, that “[t]he insured shall not, except at his own cost, make any payments, assume any obligations or incur any expense.”

Believing that there was a strong likelihood of a obtaining a complete defense judgment, and seeking to discourage potential “copycat” claims, ANI rejected all settlement offers presented. B&W, which for some time had been pressuring ANI to settle, entered into an $80 million settlement (well within the $280 million remaining policy limits) without ANI’s consent. B&W then sued ANI in state court for reimbursement of the settlement amount.

In the trial court, ANI contended that it had no obligation to reimburse Babcock & Wilcox because B&W breached the policy’s consent to settle requirement. Relying upon Cowden v. Aetna Cas. and Sur. Co., 134 A.2d 223 (Pa. 1957) (holding that “an insurer must pay a judgment in excess of policy limits for its bad faith failure to settle below policy limits”), ANI argued that, under Pennsylvania law, an insurer could only be required to reimburse its insured for a settlement reached without its consent if the insurer acted in bad faith in refusing to settle. By contrast, B&W, framing the argument as one of first impression in Pennsylvania, and relying on case authority from other states, argued that an insurer is obligated to reimburse its insured for any fair and reasonable settlement entered into in good faith, regardless of a cooperation clause.

The trial court eventually held that “an insurer, defending subject to a reservation of rights, is required to reimburse an insured for a settlement reached in violation of the consent to settle clause where coverage is found to exist and the settlement is ‘fair and reasonable’ and made in ‘good faith and without collusion.’” Applying this standard, a jury found that the settlement reached between B&W and the underlying plaintiffs was reasonable and, accordingly, ANI was obliged to reimburse B&W.

ANI appealed and the Pennsylvania Superior Court reversed and adopted Florida’s “insured’s choice” test where an insured can either: 1) accept a defense pursuant to a reservation of rights and be bound by a consent to settlement provision provided that the insurer does not act in bad faith; or 2) reject a defense pursuant to a reservation of rights and, if coverage is found, hold the insurer liable for defenses costs and the costs of any reasonable settlement.

The Supreme Court, in turn, reversed the Superior Court’s decision, holding that the “insured’s choice” test is irreconcilable with Pennsylvania law because an insured’s rejection of a defense under a reservation of rights relieves an insurer of its coverage obligation. Further, the Court criticized the “insured’s choice” as being largely illusory because many, if not most, insureds lack resources to fund an adequate defense. The Justices, however, diverged sharply as to what the applicable test should be for “determining whether an insurer is liable under its insurance policy for a settlement made by its insured without securing the insurer’s consent, when the insurer is defending the claim subject to a reservation of rights.” After reviewing the policy arguments proffered by the parties and their amici, and examining how courts in other jurisdictions have approached the issue, the Court held that “where an insurer defends subject to a reservation of rights and breaches its duty to settle . . . an insured may accept a settlement over the insurer’s refusal where the settlement is fair, reasonable, and non-collusive.” The Court’s holding was limited to situations when an insurer is defending under a reservation of rights and – because of the nature of the particular reservation of rights – its interests diverge from those of its insured. In such a situation, the “determination of whether the settlement is fair and reasonable necessarily entails consideration of the terms of the settlement, the strength of the insured’s defense against the asserted claims, and whether there is any evidence of fraud or collusion on the part of the insured.” Here, the Court held that its new standard had been satisfied and reinstated the trial court’s judgment requiring ANI to reimburse B&W for the $80 million settlement.

In dissent, Justice Eakin, joined by Chief Justice Saylor, vociferously criticized the majority’s adoption of the “fair and reasonable” standard.  In the dissenting Justices’ view, this was not a case of first impression at all. Rather, the dissenters insisted that the outcome of the case clearly was governed by the holding of Cowden, imposing liability for an excess verdict where the insurer’s failure to settle within policy limits was in bad faith. In the dissenters’ view, so long as ANI’s decision to continue defending rather than settling the underlying litigation was made in good faith, ANI was within its right to do so. The dissenting Justices criticized the new standard adopted by the Majority:

[The “fair and reasonable” standard] allows an insured to breach the contract’s requirement that the insurer must consent to any settlement when the insured anticipates an excess future verdict and, as a practical matter, permits the insured to determine for itself (in the first instance) that the insurer acted unreasonably in refusing to settle.

The majority repeatedly emphasized that not all reservations of rights are created equal, and that whether an insurers’ refusal to settle or give up its reservation of rights constitutes a policy breach must be examined on a case-by-case basis. The Court also admonished that settlements be closely vetted to ensure that they are in fact reasonable under the circumstances and non-collusive. Despite these cautionary notes, policyholders will doubtless argue that this decision gives them a broad license to settle over insurer objection, ultimately with an insurer’s money, whenever an insurer is defending subject to a reservation of rights that might defeat or limit coverage. Moreover, this decision, together with the Court’s ruling in December 2014 in Allstate Property and Cas. Ins. Co. v. Wolfe, 90 A.3d 699 (Pa. 2014), that statutory insurance bad faith claims are assignable, threaten to seriously undermine the insurer’s bargained-for rights to control the defense and settlement of claims against their policyholders.

Intellectual Property Exclusion Bars Coverage for Right of Publicity Claims

In Alterra Excess and Surplus Insurance Company v. Jaime Snyder (2015) 234 Cal.App.4th 1390, Gordon & Rees Partner Arthur Schwartz and Senior Counsel Randall Berdan obtained affirmance of a trial court judgment in the California Court of Appeal, First Appellate District. The court held an exclusion for “Infringement of Copyright, Patent, Trademark or Trade Secret” applied to preclude coverage for claims based on the right of publicity. While the court’s ruling absolved Alterra of its alleged duty to defend or indemnify, the procedural wrangling behind the scenes provides a cautionary tale for insurers.

In 2009, Maxfield & Oberton Holdings, LLC began manufacturing and distributing a desk toy, “Buckyballs”, and similar products. They all incorporated the name “Bucky” which was based on the architectural engineer and inventor, R. Buckminster Fuller. Fuller died in 1983 and, in 1985, Fuller’s Estate registered its claim as Fuller’s successor with the California Secretary of State. The Estate licensed the right to use Fuller’s name and likeness on numerous occasions, including to Apple Computer which used Fuller’s image, and others, in its “Think Different” advertising campaign. In 2004, the U.S. Postal Service licensed the rights to Fuller’s image for a postage stamp.

The Estate sued Maxfield in federal district court in Northern California alleging Maxfield had been using the Bucky name without the Estate’s consent or paying royalties to the Estate. The Estate alleged claims for (1) Unfair Competition, (2) Invasion of Privacy (Misappropriation of Name and Likeness), (3) Unauthorized Use of Name and Likeness in Violation of § 3344.1, and (4) Violation of various Business and Professions Code statutes.

Alterra’s predecessor issued a CGL insurance policy to Maxfield in 2010. Alterra provided a defense to Maxfield in the federal action under a reservation of rights and filed a declaratory relief action in San Francisco Superior Court seeking a declaration of non-coverage. Alterra named the Estate in the coverage action but later stipulated to dismiss it in return for the Estate’s agreement to be bound by the outcome.

While the federal action was pending, Maxfield dissolved. This was precipitated by the United States Consumer Product Safety Commission’s filing of an administrative complaint due to safety concerns over Buckyballs. The dissolution created several issues.

First, as a dissolved entity, Maxfield could no longer defend itself in the federal infringement action and its retained defense counsel filed a motion to withdraw. Second, following the appointment of a Trustee to administer pending and future claims against Maxfield, the Fuller Estate entered into an agreement with the Trustee that released Maxfield from liability in the federal action. But, it also purported to allow the Estate to continue to pursue the infringement action so that the Estate could obtain a judgment against Maxfield for collection from Alterra. The Estate also obtained an assignment from the Trustee to allow the Estate to pursue Maxfield’s rights against Alterra.

So the stage was set. The Estate had made it clear that, despite its release of Maxfield in the federal action, it would pursue a judgment against Maxfield, an unrepresented party that could not defend itself, for eventual collection against Alterra. Although Alterra continued to believe no coverage existed, the stakes had now increased substantially by the possible exposure to Maxfield on an uncontested judgment.

To protect itself, Alterra intervened in the federal action and asserted defenses on the merits, including the very real defense the Estate had settled and released all claims against Maxfield and the infringement action had become a sham proceeding.

The Estate then sought to re-insert itself into the San Francisco coverage action despite its prior agreement to be dismissed. The court allowed the Estate to join after which the Estate attempted to prove Alterra owed coverage to Maxfield for the federal action. In the meantime, the federal action was stayed to allow the coverage issues to be resolved. Of course, if Alterra were to prevail on coverage, the Estate’s plan would collapse.

Alterra moved for judgment on the pleadings in the coverage action on three grounds: the policy’s Intellectual Property and First Publication Exclusions, and the Estate’s settlement with the Trustee. As to the latter, Alterra contended the Estate’s deal with Maxfield’s trustee, made without Alterra’s consent, violated the policy’s “no action clause” barring any coverage obligation. Alterra cited the fundamental principle, recognized by the California Supreme Court, that a claimant may not manufacture a payday by entering into an agreement with an insured to the defending insurer’s detriment or without its consent.

The trial court granted Alterra’s motion for judgment finding the Intellectual Property Exclusion barred all coverage as a matter of law. It did not reach Alterra’s other issues. The Court of Appeal subsequently affirmed on this ground.

On appeal, the Estate contended the exclusion could not reasonably be understood to apply to “intellectual property rights” because it is not conspicuous, plain and clear. Coverage exclusions and limitations must meet two separate tests, (1) “the limitation must be ‘conspicuous’ with regard to placement and visibility,” and (2) the language must be “plain and clear.” The court explained the Intellectual Property Exclusion is on an Insurance Services Office (ISO) industry form, appears under a bold-faced heading “Exclusions,” with each exclusion’s title also bold-faced. The court found these factors satisfy the first test.

The court also concluded the Intellectual Property Exclusion plainly and clearly applies to bar coverage. The Estate argued the exclusion entitled “Infringement of Copyright, Patent, Trademark or Trade Secret” shouldn’t even be called the Intellectual Property Exclusion. But the court noted that, not only have prior courts uniformly referred to this exclusion as the “Intellectual Property Exclusion,” the Estate repeatedly referred to it in just this manner in trial court filings.

Alterra’s exclusion encompasses not only copyright, patent, trademark and trade secrets but also “other intellectual property rights,” sufficient to extend to invasion of privacy and right of publicity claims. A similar exclusion was addressed by a 2011 California appellate ruling, Aroa Marketing, Inc. v. Hartford Ins. Co. of the Midwest (2011) 198 Cal.App.4th 781. In Aroa, the court held the exclusion there barred claims based on the unauthorized use of a model’s image and likeness.

The Alterra court found the “other intellectual property rights” language in Alterra’s policy is effectively identical to the Hartford policy’s “any intellectual property rights” in Aroa. These nonexclusive listings are broad enough to encompass invasion of privacy or right of publicity claims. Even if Aroa were not on the books, the Alterra court added, it would apply the exclusion to the Estate’s claims.

The tale is not yet over. The federal action must now be dismissed. Also, the Court of Appeal’s opinion is not final. It may be withdrawn from publication, modified on rehearing, or review may be granted by the California Supreme Court. But, as things stand, Alterra’s rights have been vindicated and the Estate’s plan to collect an uncontested judgment thwarted.

New York High Court Rejects Policyholder’s Effort to Expand Reach of Late Disclaimer Statute

New York’s high court has prevented an extension of New York’s “late disclaimer” law that would have placed a new, strict time requirement on an insurer attempting to disclaim coverage.  By overruling an intermediate appellate decision, the Court of Appeals of New York preserved the current arrangement under New York law whereby an insurer will generally not lose the right to disclaim coverage based on the mere passage of time without facts supporting waiver or estoppel theories, except in the case of death and bodily injury claims.

The high court, in its June 10 ruling in KeySpan Gas East Corp. v. Munich Reins. Am. Inc., found that three insurers had not, by operation of New York’s late disclaimer statute, waived their right to disclaim coverage for environmental contamination where they had allegedly failed to issue their disclaimers “as soon as reasonably possible” after learning of the grounds for disclaimer.  The decision overturned an intermediate appellate court decision that had denied summary judgment to the three excess insurers on the basis that issues of fact remained as to whether such a waiver had occurred.

The three excess insurers were named as defendants in a declaratory judgment action brought by their insured, a property owner that had incurred losses in connection with the investigation and remediation of environmental damage at manufactured gas plant sites.  In defending the suit, the insurers raised late notice as a defense.  Following summary judgment proceedings, the intermediate appellate court decided that a jury should consider whether  the insurers waived their right to disclaim coverage by failing to meet their “obligation to issue a written notice of disclaimer on the ground of late notice as soon as reasonably possible after first learning of the accident or of grounds for disclaimer of liability.”

The Court of Appeals reversed the decision, finding that the appellate court had improperly applied New York Insurance Law§ 3420 (d) (2), New York’s late disclaimer statute, to an environmental damages claim.  While the appellate court had not cited the statute directly, the Court of Appeals noted that the appellate court had essentially applied the statute’s strict timeliness requirements.

The statute, however, which requires notice of a disclaimer “as soon as is reasonably possible,” only applies to death and bodily injury claims because, as the Court of Appeals explained, the statute was enacted to aid injured parties by encouraging the expeditious resolution of such claims.

In other contexts, including environmental remediation claims, the statute does not apply, and the mere passage of time will not deprive an insurer of its policy defenses without “the insurer’s manifested intention to release a right as in waiver, or on prejudice to the insured as in estoppel.”  Accordingly, the Court of Appeals reversed the decision and remanded the case for further proceedings.