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Insurer May Face Bad Faith Exposure Despite Payment of Policy Limits
Jillianne M. Arguello
In what has been described by commentators as a "surprising ruling," a federal court granted partial summary judgment in favor of the insurance company, but denied summary judgment with respect to the plaintiff’s claims for bad faith and alleged violation of the Washington’s Insurance Fair Conduct Act ("WIFCA"). Isilon Systems, Inc. v. Twin City Fire Insurance, Case no. 10-cv-01392.
The relevant Twin City policy ("the policy") provided Isilon and its executives with $5 million in policy limits and excess of $20 million in underlying coverage. The Policy provided coverage for "loss" defined to include litigation defense fees and costs. In 2009, the SEC filed an action (the "SEC Action") in district court alleging that former Isilon CFO Stuart Fuhlendorf had engaged in financial reporting fraud while acting in his role as Isilon CFO. The SEC action was eventually resolved in 2011 with a final judgment that enjoined Fuhlendorf from violating the Securities Exchange Act of 1934 and the Securities Act of 1933, and from acting as an executive at a securities related organization for three years.
In connection with the SEC Action, Fuhlendorf incurred litigation fees of $5 million in excess of the $20 million underlying policy limits. Prior to July 2010, Isilon indemnified Fuhlendorf for the $5 million, and sought reimbursement. Additionally, in July 2010 the plaintiff asked Twin City to begin paying Fuhlendorf’s defense fees because the underlying policy was nearly exhausted. Twin City responded by issuing a coverage denial with respect to Fuhlendorf because it believed that at the time the plaintiff applied for insurance, Fuhlendorf had knowledge or information that could have led to a claim under the policy. Shortly thereafter, the plaintiff commenced the instant action based on Twin City’s denial of coverage.
Although the Court does not entirely make clear the reasons for doing so, Twin City subsequently withdrew its denial and issued a letter indicating that it planned to pay its limits once it received proof of payment of the underlying insurance limits, subject to a reservation of rights. Twin City subsequently advanced $5 million to the plaintiff within the policy’s 90-day window for payment upon notification of exhaustion of those underlying limits, and filed a motion for summary judgment on the remaining counts pending in the action, namely: (1) violation of the Washington Consumer Protection Act ("WCPA"); (2) breach of contract; (3) breach of implied covenant of good faith and fair dealing; and (4) violation of WIFCA.
The Court’s Opinion
With respect to the alleged violation of the WCPA, the court concluded that the plaintiff’s claim failed because it could not show an injury to its business or property. Specifically, the court noted that the plaintiff could not establish an injury to its business or property caused by Twin City’s denial of coverage, because Twin City ultimately performed under the contract by paying its full policy limits. On the same basis, the court concluded that the plaintiff’s breach of contract claim failed. The court determined that Twin City’s $5 million payment, which followed the exhaustion of the underlying policy on April 27, 2011, was sufficient to conclude that it had performed according to the terms of the policy.
Turning to the plaintiff’s bad faith claim, the court denied Twin City’s motion for summary judgment because it found that a genuine issue of material fact existed with respect to the prior knowledge issue – specifically whether Fuhlendorf had knowledge of the acts, errors or omissions that might give rise to a claim under the policy at the time that Isilon applied for insurance. The court ruled that Twin City failed to show that it acted in good faith when it initially denied coverage as to Fuhlendorf, because it could not conclusively establish that Fuhlendorf anticipated the SEC claim at the time the Isilon’s application for insurance was made. Ultimately, the court determined that because it was unclear whether Twin City denied coverage in bad faith, denial of Twin City’s motion for summary judgment with respect to the bad faith claim was appropriate. For the same reason, the court denied Twin City’s motion for summary judgment with respect to the plaintiff’s statutory WIFCA claim, which was similar to the common law bad faith allegations.
Tressler Comments: Although the Isilon court’s ruling in the matter is subject to further appeal or modification, the ruling is nevertheless important because it shows that even where an insurer pays out its full policy limits in accordance with the provisions of its policy, a court might still find bad faith exposure based on the carrier’s initial coverage disclaimer. This is an unusual situation, perhaps most like cases that have found an insurer acted in bad faith despite the fact that its coverage disclaimer was ultimately upheld judicially. In those cases, however, the bad faith accompanies a denial of coverage, while in this case the potential for a bad faith exposure exists despite the payment of full policy limits (i.e., discharge of the insurer’s full contractual obligation.)
Many commentators will undoubtedly view this as a case where the court should have found no foul in the absence of any real harm to the policyholder.
Purported Notice of Claim Provided By Means of an Underwriting Application Is Inadequate
Jill A. Ellman
The Material submitted to underwriters as part of a renewal process did not meet the policy’s requirements for notification to a specified address and within a specified time period according to a federal appeals court. Atlantic Health System, Inc. v. National Union Fire Insurance Company of Pittsburgh, No. 11-2060 (3rd Cir. Feb. 29, 2012).
In the underlying matter, an antitrust lawsuit was filed in April 2004 against the insured, Atlantic Health System, Inc. ("AHS"), by Med Alert Ambulance, Inc. (the "Med Alert Lawsuit"). While renewing its policy during the 2003-2004 policy period, AHS advised National Union of the Med Alert Lawsuit in its underwriting application. The renewal applications were sent to an underwriter located at a different address than the claims department. AHS reported the lawsuit in July 2004 under a policy issued by National Union Fire Insurance Company of Pittsburgh ("National Union") effective May 1, 2004 to May 1, 2005. National Union denied coverage because AHS had notice of the underlying matter prior to the inception of the 2004-2005 policy period. In response, AHS reported the Med Alert Lawsuit in August 2004 under the prior 2003-2004 policy period. National Union again denied coverage for the claim because notice had not been provided within the policy period or the 30-day notice extension after the policy’s expiration.
The insured commenced coverage litigation seeking declaratory and monetary relief. The District Court granted summary judgment in favor of National Union, finding that the insured did not adhere to National Union’s policy provisions in that it did not (1) submit the material to the address designated for reporting a claim, and (2) did not indicate that the material was submitted as a notice of a claim as opposed to for any other reason. AHS appealed to the Third Circuit.
The crux of AHS’s claim is that National Union should have granted coverage to AHS under the 2003-2004 policy because statements made in the renewal process served as notice to National Union of the Med Alert Lawsuit. National Union countered that AHS failed to provide timely notice of the claim in accordance with the policy’s terms. The Third Circuit noted the difference between occurrence and claims-made policies as highlighted in Zuckerman v. National Union Fire Insurance Co., 495 A.2d 395 (N.J. 1985), which interpreted that claims-made policies must be applied strictly. For claims-made policies, the Third Circuit found that extending notice beyond the contracted policy period "would be inequitable and unjustified." The Third Circuit further distinguished notice provisions in occurrence policies, which are triggered by an event in the policy period, to those in claims-made policies, which are triggered by the submission of a claim. Relying on American Casualty Co. of Reading, Pennsylvania v. Continisio, 17 F. 3d 62 (3d Cir. 1994), the Third Circuit concluded that claims-made policies are less expensive because underwriters determine exposure based on a definitive period of time. Any further extension of the reporting period would increase risk to insurers and raise the cost of the policy to the insureds.
In response to AHS’s argument that it provided actual notice to National Union through its underwriting application process, the Third Circuit emphasized the ruling in Continisio, which provided that "[N]otice must be given through formal claims channels…we recognize that the information needed…varies when predicting the probability of future losses and recognizing the need to investigate a claim that may be based on past occurrences." Continisio, 17 F. 3d at 69. The Third Circuit concluded that the insureds must therefore give notice of a covered claim at the address identified by the insurer- mere mention of a claim in an application renewal process does not constitute an appropriate notice of a claim. The Third Circuit found it unreasonable that AHS would expect National Union’s underwriting department to "sift through a renewal application and decide what should be forwarded to the claims department on the insured’s behalf."
Tressler Comments: Atlantic Health System clearly outlines the consequences for policyholders who do not adhere to the policy’s notification terms. The Third Circuit properly concluded that an insured should not be entitled to coverage for failure to perform its contractual obligations. The Atlantic Health System is an informative decision for not only explaining the requirements of a claims-made policy, but also for explaining that underwriters may want and need information about prior or current claims for purposes of evaluating the risk. Thus, if a policyholder and its broker elect to provide notice of a claim for purposes of securing coverage under the policy, they should be sure to send such notice to the proper address specified in the policy or Declarations and clearly indicate the purpose for which the notice is being given.
Shareholder Fails to Adequately Plead Demand Futility Under Delaware Court of Chancery Rule 23.1
The Complaint of a shareholder, who sued executives and directors for allegedly materially understating the publicly reported expenses of a Delaware consulting corporation, was dismissed by the Appellate Court of Illinois for failure to adequately plead demand futility with respect to establishing director interest and director oversight liability. In re Huron Consulting Group, Inc., No. 1-10-3519 (Ill.App.Ct. March 27, 2012).
Plaintiff, Brian Hacias, filed this shareholder derivative suit on behalf of Delaware corporation Huron Consulting Group against several Huron executives employed at the time of the alleged incident. Hacias also named several members of the board of directors, Huron as a nominal defendant, and PricewaterhouseCoopers as Huron’s independent auditor.
During a period of rapid growth between October 2004 and October 2009, Huron allocated millions of dollars to the owners of consulting firms (“selling shareholders”) it acquired, to be distributed to the firms’ employees as financial incentives to remain employed with Huron after the acquisition. Pursuant to the “Generally Accepted Accounting Principles” (“GAAP), these bonuses to future employees, or retention payments, must be accounted for as compensation expenses in order to offset Huron’s earnings. However, between 2006 and 2009, Huron accounted for these payments as “goodwill” and thus, the payments did not offset Huron’s earnings and artificially increased Huron’s earnings per share. Huron publicly acknowledged that it improperly accounted for these incentive payments, revealing that it overstated its income by a total of $57 million.
Following this announcement, Huron’s stock dropped by more than 69 percent, which represented a market capitalization loss of more than $650 million. Hacias alleged that the members of the board earned an average of $330,438 in annual salary, “higher than the average director compensation awarded at 16 of the top 20 Fortune 500 companies.”
Hacias, in his Complaint, asserted three counts of breach of fiduciary duty against the directors and executives and alleged a separate count of breach of fiduciary duty against the directors alone. He also asserted several other claims, including unjust enrichment and gross mismanagement.
Huron and the director defendants (“defendants”) filed a motion to dismiss Hacias’ Complaint. They argued that Hacias lacked standing to bring the claim on Huron’s behalf because Hacias had not established that making a demand on Huron’s directors would have been futile and Hacias failed to state a claim for relief with respect to the 10 derivative claims. In support of their motion, defendants attached the Declaration of an associate at Cravath, Swath, & Moore LLP and counsel to Huron. Attached to this Declaration were “true and correct” copies of 14 documents, including public filings of Huron and other consulting groups and a memorandum of law in support of the defendants’ motion to stay a cause of action pending in federal court. The circuit court granted defendants’ motion to dismiss with prejudice for failure to satisfy Delaware law and relied on the documents contained in the Declaration attached to defendants’ motion to dismiss. Hacias appealed.
In its analysis of the validity of the derivative suit, the Appellate Court of Illinois noted that the demand requirement is not “merely a matter of procedure.”It further noted that since corporations are “creatures of state law,” the substantive law of the state of incorporation applies in determining whether the shareholder has adequately established that he has satisfied the demand requirement to proceed with litigation on the corporation’s behalf. As Huron was incorporated in Delaware, the demand requirement was governed by Delaware Chancery Rule 23.1.1 Under 23.1, a demand requirement would be deemed futile where the shareholder established that there is a reason to doubt the board’s ability to evaluate the demand in a disinterested and independent manner.
The Court ultimately determined that Hacias failed to meet the burden of pleading with particularity that demand was futile. First, the Court noted that demand futility claims are analyzed under one of two legal standards. Under the Aronson standard, demand is excused if the “derivative complaint pleads particularized facts creating a reasonable doubt that (1) the directors are disinterested and independent or (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.” Hacias challenged a specific business decision of the directors, claiming that the directors were “interested,” as that term is defined under Delaware state law2, because they engaged in conduct that was not protected by the business judgment rule (i.e. they retained defendant Gary Burge as treasurer for five months after his employment was terminated). Hacias also alleged that the directors wasted corporate assets by continuing to pay Burge a salary during those months.
The Court determined that Hacias failed to allege that the directors received a personal financial benefit by retaining Burge as treasurer and that they would be personally detrimentally impacted in a way not equally shared by the stockholders by not retaining Burge. In addition, according to the Court, Hacias did not show, through particularized pleading, that Burge failed to adequately perform his duties as treasurer. Thus, Hacias failed to overcome the presumption of good faith decision making that is the crux of the business judgment rule.
Under the second legal standard, the Rales standard, demand is excused only where “the particularized factual allegations create a reasonable doubt that, [at] the time the complaint was filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” This standard applies where the subject of the derivative suit does not attack an affirmative decision of the board.
Reviewing Hacias’ Rales claim, the Court determined that Hacias failed to establish that the majority of the directors lacked independence because he had not demonstrated which of the directors they were beholden to or how the directors would be “interested.” While Hacias asserted that directors lacked independence from each other, he neither asserted nor demonstrated that the directors were “interested,” instead merely comparing the salaries of the directors with the salaries of directors of other Fortune 500 companies.
Accordingly, having determined that Hacias failed to adequately allege particularized facts establishing that demand on the directors would have been futile under 23.1, the Court also determined that Hacias failed to make a proper motion for leave to amend his Complaint. The Court affirmed the circuit court’s decision dismissing Hacias’ complaint.
1 Delaware Chancery Rule 23.1 provides that: “The complaint shall also allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or not.” The Court noted that the directors must be allowed to “rectify an alleged wrong without litigation, and to control any litigation which does arise.”
2 An “interested” director is one who “receive[s] a personal financial benefit from a transaction that is not equally shared by the stockholders.”
Tressler Comments: This case stresses the importance of plaintiffs adhering to state requirements for demand futility. Although the case was brought in Illinois, Delaware law required that the plaintiff shareholder sufficiently show that the directors are disinterested, as defined under state law, and are liable for oversight. This case also contains comprehensive discussions of res judicata, collateral estoppel and the requirements for a demand futility claim under Delaware law.
Restitution By Insured in Fraud Case Did Not Constitute Covered Damages
Elizabeth M. McGarry
An insurance policy did not cover the amount that the insured agreed to refund to a purchaser of subsidiaries to settle fraud claims. The Seventh Circuit held that if the insured could obtain reimbursement for the settlement amount “it will have gotten away with fraud.” The court found that a covered “loss” does not include restitution paid by an insured, and is distinct from damages, which are expressly denoted as covered under the policy. Ryerson Inc. v. Federal Insurance Company, 2012 U.S. App. LEXIS 7372, (7th Cir. April 12, 2012) (applying Illinois law).
In 1998 Ryerson, Inc. sold a group of subsidiaries to EMC Group, Inc. for $29 million. The following year EMC sued Ryerson seeking rescission of the sale and restitution of the purchase price. EMC argued that Ryerson concealed an impending development affecting one of its subsidiaries. The subsidiary’s largest customer had declared that unless it cut prices, the customer would build its own plant and stop buying from the subsidiary. The customer repeated the demand for a price cut to EMC when EMC acquired the subsidiary from Ryerson. When EMC failed to accede to the demand, the customer took its business elsewhere. EMC’s suit charged Ryerson with fraudulent concealment intended to induce EMC to buy the subsidiary, breach of contract, and breach of warranty.
At the time of suit, Ryerson was insured by an insurer under an “Executive Protection Policy.” The policy covered “all LOSS for which [the insured] becomes legally obligated to pay on account of any CLAIM … for a WRONGFUL Act [elsewhere defined in the policy to include a ‘misleading statement’ or ‘omission’] …. allegedly committed by” the insured. Ryerson demanded coverage for the EMC Lawsuit. The insurer refused on the ground that EMC’s claim against Ryerson was not a covered risk.
Three years into EMC’s suit against Ryerson, the parties settled, with Ryerson agreeing to make “a post-closing price adjustment” of $8.5 million. The insurer maintained that EMC’s claim against Ryerson was not a covered risk. Ryerson brought a declaratory judgment action seeking a finding that the policy covered the $8.5 million that Ryerson refunded to EMC to settle the lawsuit.
In the declaratory action, the insurer argued that a “loss” covered by the policy does not include restitution paid by the insured, as distinct from damages, which are expressly denoted in the policy as a covered loss. The Seventh Circuit agreed. The court noted that a claim for restitution is a claim that the defendant has something that belongs of right, not to him, but to the plaintiff. A claim for “damages,” on the other hand, is claim for the monetary equivalent of the harm that was done to the plaintiff.
The court noted that Ryerson received $29 million from EMC for the subsidiaries and agreed to give back $8.5 million to settle EMC’s fraud claims against it. The refund represented a return of part, or maybe all, of the profit that Ryerson had obtained by inducing EMC to overpay. If Ryerson could obtain reimbursement of that amount from the insurance company, it would have gotten away with fraud. The court reasoned that if “disgorging such proceeds is included within the policy’s definition of ‘loss,’ thieves could buy insurance against having to return money they stole.” The court pointed out that no one writes such insurance, and no state would enforce such an insurance policy if it were written. A person cannot, at least for insurance purposes, sustain a “loss” of something it does not (or should not) have. Furthermore, there is no insurable interest in the proceeds of fraud. Because EMC was seeking to recover a profit made at its expense by Ryerson’s fraud (i.e. a claim for restitution), the claim was not covered by the policy.
The court made a point to note that a judgment or settlement in a fraud case may involve a combination of restitution and damages. Under those circumstances, the insurance company would be liable for the damages portion in accordance with the allocation formula in the policy. However, because Ryerson made no effort to allocate its loss between the loss of ill-gotten gains and other costs (i.e. transaction costs), any claim to those costs had been forfeited.
Tressler Comments: This case illustrates the important distinction between restitution and covered “damages.” Insurers generally are not bound to reimburse an insured for any and all monetary judgments and/or settlements. Rather, based upon the explicit language of the policy, an insurer will likely only be responsible for indemnifying its insured for those amounts that can properly be categorized as “damages.” An insurer should carefully examine the basis for a monetary judgment or settlement against its insured, particularly in cases involving fraud claims, to determine if the amount constitutes covered “damages.”
Ninth Circuit Upholds Denial of Coverage Under E&O Policy As Insured Had Notice of the Claim Well Before the Policy’s 30 Day Provision.
Michaela L. Sozio
The court held that the insured realty company was not entitled to coverage for claims that were reported to its E&O carrier during the policy period, but were noticed to the insured earlier than - and thus outside of - the policy’s 30-day notice requirement. In Re/Max Mega Group v. Maxum Indemnity Co., Case No. 11-55142 (9th Cir. March 12, 2012).
Maxum Indemnity Company (“Maxum”) issued a Professional Liability Claims Made Policy to Re/Max Mega Group (“Re/Max”), effective December 22, 2006 through December 22, 2007. The Declarations Page provided that the Retroactive Date was the inception date of the policy, December 22, 2006, and that the coverage does not apply to any “negligent act, error or omission” that occurs before that date. The Maxum policy further provided that claims must be reported to Maxum “as soon as practicable, but in no event later than thirty (30) days after notice to any insured.”
Re/Max and one of its agents, Lynn Kim (“Kim”), represented Suk Young Yoo (“Yoo”) in the purchase of a residence located in Rancho Palos Verdes. The purchase and sales agreement for the subject property was entered into on October 19, 2006. The seller failed to disclose material facts regarding the subject property, and Yoo contended that Kim and Re/Max also knew and/or should have disclosed facts about the subject property. Before any lawsuit was filed, Yoo’s attorney sent a letter dated January 26, 2007, to Re/Max advising of Yoo’s claim against Re/Max. Additional correspondence followed on February 8, 2007, and February 22, 2007, which included threats of filing a lawsuit unless Re/Max would agree to participate in mediation. Mediation took place on April 6, 2007, but was unsuccessful. Yoo proceeded with filing a lawsuit against Re/Max on May 7, 2007. The first time that Maxum was advised of the Yoo claim was after the filing of the litigation -- on June 6, 2007, when Maxum received a copy of the Yoo Complaint.
On or about June 11, 2007, Maxum declined coverage on the basis that the alleged “negligent acts, errors or omissions” occurred prior to the Retroactive Date of the policy, and therefore the claim and underlying litigation were not covered. The denial letter further stated that Maxum was not waiving any other rights or privileges under the terms and conditions of the policy. Re/Max then filed a coverage and bad faith suit against Maxum in Los Angeles County Superior Court. The case was removed to federal court.
Maxum filed a motion for summary judgment arguing that no potential for coverage existed under the terms and conditions of the policy and it did not act in bad faith in denying the claim. The District Court struck Re/Max’s opposition to the summary judgment motion as it was filed late, and granted Maxum’s motion, relying only on Maxum’s moving papers. Re/Max’s motion for reconsideration was denied, and an appeal followed.
In its unpublished opinion, the Court of Appeals for the Ninth Circuit affirmed the ruling of the District Court. First, the District Court was found not to have abused its discretion in striking the opposition after it had previously admonished Re/Max for filing its opposition papers late once before and warned Re/Max that any future oppositions must be timely filed. Secondly, the Court of Appeals found that the District Court’s granting of summary judgment in favor of Maxum was not “a mere sanction for noncompliance with local rules,” but that the District Court had correctly found that Maxum had set forth sufficient evidence and had met its burden of demonstrating that there was no genuine dispute as to any material fact.
Specifically, the Ninth Circuit relied on the undisputed facts that Re/Max had notice of Yoo’s letters in January 2007 (or, by early March 2007 at the latest), but did not report the claim or forward the letters to Maxum until later May/June 2007, almost two months after the 30-day deadline in the policy had passed. While Re/Max took the position that the January 2007 and February 2007 letters did not constitute “claims” within the meaning of the policy, the Ninth Circuit disagreed and found that Yoo’s letters constituted claims because they asserted that Re/Max was liable for negligence and fraud, threatened a lawsuit, requested a mediation, and included a copy of a civil complaint for damages. Thus, they constituted written demands for money or services.
Re/Max further argued that Maxum had waived the right to rely on the 30-day notice provision in the policy to disclaim coverage because it had not mentioned or asserted this position in its denial letter. The Ninth Circuit again disagreed, finding that Maxum had expressly stated in the denial letter that it did not intend to “waive any other rights or privileges under the terms and conditions of the policy.” Moreover, as the Ninth Circuit pointed out, Maxum was not even aware at the time it sent the denial letter on June 11, 2007, that Re/Max had received notice of this claim by early March 2007 at the latest. Accordingly, the judgment was affirmed in favor of Maxum.
Tressler Comments: Most importantly, this case illustrates the importance of a general savings clause in any coverage position letter. Here, such language took the form of the insurer expressly stating that it was not waiving any rights or privileges that may exist under the terms and conditions of the policy.
It is also interesting that the Court of Appeals focused on only two issues here – first, the notice to the insured argument and second, the issue of whether or not it was an abuse of discretion by the District Court in striking Re/Max’s opposition. But, in Maxum’s moving papers, it also argued that its motion should be granted because the underlying acts of its insured happened before the policy’s retroactive date. This argument was, in fact, Maxum’s main position in moving for summary judgment, yet it warranted no comment or apparent consideration by the Court of Appeals. The Court chose to instead focus on arguments centered on the insured or its counsel respectively acting in an untimely/late fashion – the late reporting to Maxum by the insured and the late filing by its counsel.
Intentional Misrepresentations Not Required for Rescission of Legal Malpractice Liability Policy
Jonathan M. Feinstein
The Sixth Circuit affirmed the district court’s grant of summary judgment in favor of the insurance carrier for rescission of a legal malpractice liability policy based on a lawyer’s material misrepresentations on the application, involving a failure to disclose a pending malpractice investigation. Cont’l Cas. Co. v. Law Offices of Melbourne Mills, Jr., PLLC, 2012 U.S. App. LEXIS 7445 (6th Cir. KY. April 13, 2012) (applying Kentucky law).
In February 2002, lawyer, Melbourne Mills, Jr. (“Mills”) learned that the Kentucky Bar Association (“KBA”) was investigating complaints filed against him for collecting excessive fees in connection with a large class action settlement. In August 2003, Mills applied to renew his professional liability insurance with an insurer for the 2003-2004 period. Question 3 of the application asked:
“Are there any claims, or acts or omissions that may reasonably be expected to be a claim against the firm, that have not been reported to the Company or that were reported during the expiring policy period?”
In response, Mills checked “No,” but noted “See Schedule 2.” Schedule 2, entitled E&O Claims, stated: “In addition to Melbourne Mills, Jr., the lawyers currently serving in the firm include two of counsel partners, David L. Helmers and E. Patrick Moores. The information regarding the of counsel attorneys is contained on the attached attorney information sheet.”
Question 4 of the 2003 application asked:
“Has any attorney been disbarred, suspended, formally reprimanded or subject to any disciplinary inquiry, complaint or proceeding for any reason other than non-payment of dues during the expiring policy period?”
Again, Mills checked “No,” but indicated “See Schedule 3.” Schedule 3, entitled Disciplinary Proceedings, stated:
During the current year no attorney has been disbarred, suspended, formally reprimanded or subject to any disciplinary inquiry, complaint or proceeding. In prior years, attorneys in the Firm have responded to inquiries filed by all jurisdictions exercising jurisdiction and control over attorney conduct. There have been no adverse findings regarding any attorney or other party’s conduct.
Subsequently, in August 2003, Continental issued an insurance policy, entitled Lawyers’ Professional Liability Policy, to the Law Offices of Melbourne Mills, Jr. Thereafter, in 2005, the class members asserted a legal malpractice claim against Mills and others in Abbott, et al. v. Chesley, et al. In Abbott, the Circuit Court found that the attorneys, including Mills, “breached their fiduciary duties to the Plaintiffs when they paid themselves fees over and above the amount to which they were entitled to under their fee contracts with their clients.” The class plaintiffs were awarded $42 million. The insurer initially provided Mills a defense, including the right to rescind the policy under a full reservation of rights. The insurer then sought a judicial declaration that it was entitled to rescind the policy for the period covering August 21, 2003, to August 21, 2004. Mills and the class members, who intervened to protect their ability to recover against Mills, argued that because Mills’ misrepresentations were not intentional, they were not material, and thus the policy should not have been rescinded.
According to Kentucky statute, K.R.S. § 304.14-110, a misrepresentation voids an insurance policy if the misrepresentation is “material” to the acceptance of risk or if the insurance company would not have issued the policy if the true facts had been made known. Based on this language, the court rejected Mills’s argument and held that the plain language of the statute merely requires that the misrepresentation be “material” and not “intentional.”
The district court granted summary judgment in favor of the insurer and the Sixth Circuit affirmed finding that the policy was void due to Mills’s response to Question 3 and Question 4 of the application.3 The court found that Mills’ answer to Question 3 was a misrepresentation because when he was filling out the application, Mills not only knew of the ongoing KBA investigation, but also had personal knowledge that the acts involving the class action settlement negotiations would likely result in a malpractice claim against him. The facts established that the insurer would not have issued the policy, or would have issued a different policy, if it had knowledge of Mills’ actions and omissions.
Lastly, the Sixth Circuit rejected Mills’ argument that Question 3 reflects the “subjective state of the applicant’s mind,” and thus the question of materiality should have been determined by a jury. The court stated that because Mills knew that there was the potential for a “claim” against him, the only possible and acceptable answer to Question 3 was “Yes” instead of Mills’ “No.” Therefore, the court held that Mills made a material misrepresentation in his malpractice insurance application, and that the policy was properly voided under Kentucky law.
3 The Sixth Circuit noted that the insurer also could have declined coverage under the “Dishonesty Exclusion” clause of the policy because The Kentucky Supreme Court determined that Mills had committed “dishonest” and “fraudulent acts or omissions.” The Sixth Circuit held that the Supreme Court’s finding sufficiently triggered the policy’s exclusion.
Tressler Comments: This case highlights the importance of appreciating the applicable state’s law as states have different standards for rescission. This court rightfully prohibited the insured from substituting the clear meaning of “material” for “intentional” in order to raise ambiguity and avoid rescission of the policy at issue.
No "Stretching the Tail:" No Coverage Under Claims-Made Policy Where Insured Delayed Two Years in Providing Notice
Elizabeth L. Musser
The California Court of Appeal affirmed a trial court’s ruling that no coverage is available for a TPA insured, where the insured delayed notifying its carrier until two years after it was sued, and the subject claims were made and reported after the claims-made policy period. NovaPro Risk Solutions, L.P. v. TIG Insurance Company, Case No. D059066, 2012 Cal. App. Unpub. LEXIS 2035 (Cal. Ct. App. Mar. 16, 2012).
NovaPro Risk Solutions, L.P. (f/k/a Ward North America, Inc.) was a third party administrator for certain commercial auto liability and property policies issued by United States Fidelity and Guaranty Company (“USF&G”), under a program known as the Red Hawk Insurance Services Program. During the period it administered Red Hawk claims, NovaPro carried professional liability insurance under a series of claims-made policies issued by TIG Insurance Company (December 31, 2000 to December 31, 2001), Kemper Insurance and Liberty Surplus Insurance Company.
In November 2001, during the TIG policy period, NovaPro allowed default judgment in excess of $400,000 to be entered against one of USF&G’s Red Hawk insureds, White Knight Limousine Service. NovaPro tendered USF&G’s resulting claim against NovaPro (the “White Knight Claim”) to TIG. TIG defended, and NovaPro and USF&G settled the White Knight Claim in 2004 for a release and payment.
On November 3, 2005, USF&G filed an action against NovaPro (the “USF&G Action”) asserting negligence, breach of contract, breach of fiduciary duty and negligent misrepresentation as a result of NovaPro’s alleged “program wide” mishandling of Red Hawk claims. NovaPro tendered the USF&G Action to Liberty, which agreed to defend. NovaPro did not notify TIG of the USF&G Action until January 2008, apparently when it was prompted to do so by Liberty. A list of mishandled claims at issue in the USF&G Action that was prepared by USF&G’s expert included the White Knight Claim, among many other claims. However, the court in the USF&G Action granted NovaPro’s motion in limine to exclude evidence of the White Knight Claim entirely, based on the parties’ March 2004 settlement and release. Also, in various discovery responses served in the USF&G Action, NovaPro conceded that the White Knight Claim was not related to claims at issue in the USF&G Action.
In the meantime, Liberty rejected several policy limits demands from USF&G for $1 million or less, and a $6.6 million verdict was entered against NovaPro in November 2008. Following the verdict, and again apparently at Liberty’s urging, NovaPro advised TIG that the USF&G Action could be covered under the TIG policy as part of the White Knight Claim. TIG responded that no coverage was available, because the claims at issue were not first made and reported during TIG’s December 31, 2000 to December 31, 2001, policy period.
In this action, NovaPro asserted that TIG has an obligation to defend and indemnify it under the TIG policy in the USF&G Action, because the 2005 claims at issue in the USF&G Action are related to the 2001 White Knight Claim.
TIG filed a motion for summary judgment against NovaPro, asserting that (1) it had no duty to defend or indemnify NovaPro, because the claims in the USF&G Action and the White Knight Claim were not logically or causally related; and (2) it had no duty to defend the USF&G Action because NovaPro provided notice more than two years after the Action incepted. The trial court granted TIG’s motion, and NovaPro appealed.
The appellate court affirmed. As an initial matter, the court noted that the TIG policy is a claims-made policy that provides coverage only for claims first made against NovaPro during the policy period, and reported to TIG during the policy period or within a 30-day extended reporting period. Here, it is undisputed that the USF&G Action was filed in November 2005, and that NovaPro gave notice to TIG more than two years later, in January 2008. The appellate court cited Homestead Insurance Company v. American Empire Surplus Lines Insurance Company, 52 Cal. Rptr. 2d 268 (Cal. Ct. App. 1996) for the proposition that the insured cannot invoke the TIG policy’s related acts provision to “stretch the tail” of the policy to cover claims first made and reported years after the TIG policy expired. The claims in the USF&G Action and the White Knight Claim involve separate claims files, separate adjusters, separate injuries, and different acts, errors and omissions, and therefore are not “related.” The White Knight Claim involved a single default judgment, whereas the USF&G Action involves an assertion of program-wide mismanagement of Red Hawk claims.
In any event, NovaPro delayed more than two years in providing notice of the USF&G Action to TIG, and even when it provided notice did not ask TIG to defend it. Finally, NovaPro had no damages because it was fully defended by Liberty in the Action.
Tressler Comments: In this case, the appellate court found that no coverage is owed under a claims-made policy for a host of reasons: the claims for which the insured sought coverage were not made or reported during the policy period and were unrelated to prior claims, the insured explicitly took the position that the claims at issue were not related to prior claims, the insured had no damages because it was fully defended in the subject lawsuit, and the insured did not expressly seek a defense or indemnification from the carrier. Most importantly, however, the insured failed to provide notice of the subject action to its carrier until more than two years after suit was filed. This delay made it easy for the appellate court to deny coverage.
Please note that because this decision has not been certified for publication by the California Court of Appeal, it cannot be cited as authority in cases pending in California state courts.
Fidelity Corner: District of New Jersey Holds Loan Servicing Contractor Was Acting as the Insured Credit Union’s Employee When It Sold the Credit Union’s Mortgages to Fannie MaeThird Parties
James A. Knox and Abigail E. Rocap
Fidelity bonds for financial institutions may cover not only the institution’s own employees but also independent contractors engaged to service the institution’s loans. The question then can be how far does that coverage go? An insurer’s attempt to use its employee definition to limit the coverage of the insured’s servicing contractor to its servicing activities fell on hard times in Sperry Associates Federal Credit Union v. Cumis Insurance Society, Inc., No. 10-00029, 2012 U.S. Dist. LEXIS 26839 (D.N.J. Mar. 1, 2012).
The insured credit union hired CU National Mortgage, LLC (“CUN”) to service real estate loans secured by mortgages to the credit union’s members. CUN promised not to sell the loans and mortgages but proceeded through its parent company to fraudulently sell them to Fannie Mae. By issuing false reports and sending some money to the credit union, CUN made it look as if it was servicing the mortgages as agreed, but CUN was sending the actual mortgage payments to Fannie Mae. A loss ensued and the credit union claimed Employee Dishonesty coverage under its fidelity bond.
The bond defined employee to include a servicing contractor but only when authorized to “collect and record payments on real estate mortgage or home improvement loans” and “only while performing such services.” The insurer argued CUN did not meet this definition for its conduct in question because it had no authority to sell mortgages to Fannie Mae. The court found otherwise: CUN acted as an employee because “the Bond-covered activity of collecting and recording was integral to the origination, perpetration, and concealment of the fraudulent scheme.” The credit union was led to believe it still owned the loans and CUN was still servicing them for its account. The court also found that CUN had what the bond specified as dishonest intent; CUN had “intent” to cause the insured a loss “or” obtain an improper financial benefit. CUN profited by pocketing the proceeds from its sale of the mortgages to Fannie Mae. Finally, the court found that the loss, as the bond required, was a direct result of CUN’s dishonest acts. The loss occurred when CUN stole the credit union’s notes and sold them to Fannie Mae. It was not an indirect loss from the credit union’s settlement of its dispute with Fannie Mae over who owned the mortgages. That settlement merely mitigated the loss. The court entered summary judgment for the credit union and refused to dismiss its bad faith claim against the insurer.
Marsh and Tressler LLP Present the 2012 Directors & Officers Liability Briefing – Changing Times in D&O Insurance -- on Four Separate Dates in Four Different Cities
Los Angeles Partner Michaela L. Sozio and New York Partner Joseph P. Monteleone are joining experts from Marsh’s Financial & Professional Practice in presenting the briefing from 8 a.m. to 10 a.m. on the following date:
Thursday, May 24 | Orange County - Center Club
650 Town Center Drive | Costa Mesa, CA 92626
WHO SHOULD ATTEND
Chief Executive Officers, Chief Financial Officers, General Counsels, Vice Presidents of Finance, Treasurers, Controllers and Risk Managers.
213 346 5853
To reserve your spot, register online at:
ABOUT THE BRIEFING
While the D&O insurance market has witnessed 10 years of continuous price softening, recent insurance renewals have reflected a shift in the marketplace. Additionally, company executives and directors continue to face increased personal liability due to an active plaintiff’s bar and greater regulatory scrutiny. Shareholder derivative suits are also more commonplace and mergers and acquisitions activity has caused a surge in litigation.
As company executives learn to operate in the evolving legal and regulatory environment, it has become more important than ever to ensure a company’s D&O insurance policy evolves with the trends. Companies also need to understand the D&O insurance marketplace dynamics and how best to position themselves with insurance companies to ensure coverage terms and pricing remain optimal.
Experts from Marsh’s Financial & Professional Practice and Tressler partners Michaela L. Sozio and Joseph P. Monteleone will provide insight surrounding the rapidly changing legal environment and how the insurance market is responding.
The discussion will also address key questions such as:
What are some key D&O liability legal trends on the horizon?
What impact has the M&A environment had on litigation trends and D&O insurance?
What are the recommended strategies for placing D&O insurance in a changing marketplace?
This newsletter is for general information only and is not intended to provide and should not be relied upon for legal advice in any particular circumstance or fact situation. The reader is advised to consult with an attorney to address any particular circumstance or fact situation. The opinions expressed in this newsletter are those of the authors and not necessarily those of Tressler LLP or its clients. This announcement or some of its content may be considered advertising under the applicable rules of the Supreme Court of Illinois, the courts in New York and those in certain other states. For purposes of compliance with New York State Bar rules, our headquarters are Tressler LLP, 233 S Wacker Drive, 22nd Floor, Chicago, IL 60606, 312.627.4000. Prior results described herein do not guarantee a similar outcome. The information contained in this newsletter may or may not reflect the most current legal developments. The articles are not updated subsequent to their inclusion in the newsletter when published.