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Ninth Circuit Holds Extrinsic Facts Triggered Duty to Defend

In its recent decision in Burlington Ins. Co. v. CHWC, Inc., 2014 U.S. App. LEXIS 3941 (9^th Cir. Mar. 3, 2014), the United States Court of Appeals for the Ninth Circuit, applying California law, had occasion to consider an insured’s obligation to consider extrinsic facts in determining a duty to defend.

The underlying incident in Burlington involved injuries allegedly suffered by the plaintiff when forcibly removed by bouncers from the insured nightclub, Crazy Horse.  Claimant’s original lawsuit contained a cause of action for assault and battery for the alleged incident, as well as causes of action for negligent hiring and premises liability.  Crazy Horse’s insurer, Burlington, was provided copies of the pleadings as well as police reports concerning the incident.  The initial police reports were consistent with an assault and battery.  A supplemental report, however, indicated that while claimant was being removed from the club, he became defiant and began to resist removal.   One of the witnesses interviewed in the supplemental report stated that during this period of heightened tension, the claimant backed into a stool and fell down and that this is what may have caused his injuries.

Based on these facts, in particular the allegations in the complaint alleging that plaintiff’s injuries resulted solely from an assault and battery, Burlington denied coverage to Crazy Horse pursuant to its policy’s assault and battery exclusion.  Burlington later received summary judgment in its favor from a California federal district court.  The lower court held that due to the assault and battery exclusion, and the allegations in the underlying complaint, “there was never a possibility of coverage.”

On appeal, however, the Ninth Circuit held that the reference in the police report to the claimant falling on a stool raised the possibility that his injuries were not solely the result of an assault and battery.  Citing to the seminal California decision in Gray v. Zurich Ins. Co., 419 P.2d 168, 176 (Cal. 1966) concerning an insurer’s duty to consider extrinsic facts in determining the duty to defend, the court noted that while some aspects of the police reports substantiated an assault and battery, “some of the witness statements provided to Burlington stated that [claimant] was injured when he tried to sit down on a stool, lost his footing, and hit his head on the wall.”  This version of event, explained the court, if truly the cause of claimant’s injuries, would not fall within the assault and battery exclusion. 

Thus, explained the court, notwithstanding the actual allegations in the pleadings, and notwithstanding the witness statements in the police reports suggesting that claimant was injured solely as a result of force applied by the Crazy Horse bouncers, the extrinsic facts at least raised the possibility of coverage, which was sufficient to trigger a duty to defend.  As the court explained:

Although as originally pleaded [claimant’s] negligence claim was predicated on the theory that he had been assaulted, the extrinsic facts available to Burlington revealed the possibility that [claimant] could amend his negligence claim to allege theories of liability that would fall outside the assault-or-battery exclusion. Under well-settled California law, that possibility was enough to trigger Burlington's duty to defend.

California Court Denies Summary Judgment on Known Conditions Exclusion

In its recent decision in Lennar Mare Island v. Steadfast Ins. Co., 2014 U.S. Dist. LEXIS 26405 (E.D. Cal. Feb. 28, 2014), the United States District Court for the Eastern District of California had occasion to consider the relationship between a fixed site pollution liability policy and a remediation cost containment policy.

The Lennar decision concerns environmental liabilities at a former Naval base on Mare Island in Vallejo, California.  The site was transferred to the City of Vallejo in 2002.  The City agreed to undertake an environmental remediation of the site that would be funded by the Navy.  The City later transferred the property to Lennar Mare Island, LLC (“LMI”).  LMI, in turn, contracted with CH2M Hill Constructors, Inc. (“CCI”) to perform the required environmental remediation.

Steadfast Insurance Company issued two policies relevant to the site.  First, it issued a Remediation Stop Loss policy to CCI (the “RSL Policy”), providing cost overrun protection with respect to CCI’s remediation efforts.  Second, Steadfast issued an Environmental Liability Insurance policy (the “ELI Policy”) to LMI that insured against cleanup costs resulting from a pollution condition not known to LMI prior to the policy period, but instead first discovered during the policy period. 

The Steadfast policies referenced each other in an effort to ensure that they did not provide overlapping coverage.  Thus, the ELI Policy defined “Known Pollution Conditions” as:

… all conditions specifically described in the Scope of Work Endorsement to the Remediation Stop Loss Policy . . . and which require or  may ultimately require any form of remedial investigation or action . . .

The Scope of Work Endorsement in the RSL Policy, in turn, made reference to the conditions and activities specifically outlined in that policy and certain attachments thereto.  The RSL Policy also contained the term Known Pollution Conditions, which it defined as being limited to the conditions described in the Scope of Work Endorsement requiring any form of remedial investigation or action. 

At issue in the Lennar decision was LMI’s right to insurance coverage for PCB contamination in Building 116 of the site.  The RSL Policy’s Scope of Work Endorsement, and certain attachments thereto, made reference to PCB contamination in concrete floor slabs in Building 116.  The endorsement also referred to PCB contamination in transformer pads in Building 116.  The RSL Policy did not, however, make reference to PCB contamination in the wood floor of Building 116.  Thus, when CCI encountered PCB contamination in the building’s wood floor during the policy period, a question was raised as to whether LMI was entitled to remediation cost coverage for this contamination under the ELI Policy. 

LMI filed a declaratory judgment action and promptly moved for summary judgment.  Steadfast stated in opposition to the motion that it had obtained several documents suggesting that LMI and/or CCI was aware of the PCB contamination in the wood floor prior to the inception date of the ELI Policy, and thus it may be a Known Pollution Condition for which coverage was unavailable.  Steadfast argued, therefore, that at a minimum, it should be entitled to further discovery on the issue.  Steadfast, in fact, had been pursuing such additional discovery but was mired in several non-party discovery disputes at the time LMI filed for summary judgment.  LMI countered that any such discovery was irrelevant, since the ELI Policy defined the term Known Pollution Conditions as anything identified in the RSL Policy’s Scope of Work Endorsement, and that as such, anything not identified in the Scope of Work Endorsement was not a Known Pollution Condition.  In other words, because the Scope of Work Endorsement did not specifically identify PCB contamination in the wood floor of Building 116, it necessarily followed that this could not be a Known Pollution Condition for the purpose of the ELI Policy, regardless of when LMI first became aware of or discovered this condition.

The court disagreed with LMI’s reading of the two policies.  While the RSL Policy stated that only those conditions specifically identified could be considered Known Pollution Conditions for the purpose of the RSL Policy, the definition of Known Pollution Conditions in the ELI Policy contained no similar restriction.  In other words, an area of contamination could be considered a Known Pollution Condition for the purpose of the ELI Policy even if not specifically identified in the RSL Policy’s Scope of Work.  In any event, the ELI Policy’s insuring agreement made clear that coverage was unavailable for any pollution condition discovered outside of the policy period.  The court reasoned that LMI’s interpretation of the ELI Policy “that anything not listed as a known condition in the RSL Policy necessarily was discovered during the policy period – would collapse the two provisions of the ELI Policy [i.e., the discovery requirement and the known conditions prohibition] into one.”  Thus, the court denied LMI’s motion for summary judgment without prejudice, and permitted Steadfast additional time to take discovery into the known conditions issue.

Maryland Court Holds Prejudice Rule Applies to Claims Made and Reported Policy

In its recent decision in Navigators Specialty Ins. Co. v. Med. Benefits Administrators of Maryland, 2014 U.S. Dist. LEXIS 22631 (D. Md. Feb. 21, 2014), the United States District Court for the District of Maryland had occasion to consider whether Maryland Code § 19-110, which establishes a prejudice requirement for late notice disclaimers, applies to claims made and reported policies.

Navigators insured Medical Benefits Administrators of Maryland (“MBA”) under successive claims made and reported professional liability policies for periods October 31, 2009 to October 31, 2010 and October 31, 2010 to October 31, 2011.  MBA was a claims administrator for Brit Insurance with respect to employer benefit plans.  A dispute arose between Brit and MBA concerning funds that MBA allegedly failed to repay or reconcile, and litigation ultimately followed.

While the parties disputed when Brit first asserted its claim against MBA – prior to the first of the two policies or during the term of one of the policies – the court ultimately determined that the claim was first made while the 09-10 Navigators’ policy was in effect.  MBA, however, did not report the claim to Navigators until July 2011.  Navigators thus contended that MBA’s failure to have reported the claim prior to the October 31, 2010 expiration of the 09-10 policy vitiated any right that MBA had to coverage under that policy.  MBA countered that under Maryland law, its failure to have reported the claim while the 09-10 policy was still in effect would only serve as a bar to coverage if Navigators was actually prejudiced as a result.

In support of its assertion, MBA relied on Maryland Code § 19-110, which states:

An insurer may disclaim coverage on a liability insurance policy on the ground that the insured . . . has breached the policy by failing to cooperate with the insurer or by not giving the insurer required notice only if the insurer establishes by a preponderance of the evidence that the lack of cooperation or notice has resulted in actual prejudice to the insurer.    

While this rule has been applied routinely to occurrence-based policies, the court noted that there were only a handful of Maryland cases that considered it in the context of claims made and reported policies.  In Sherwood Brands, Inc. v. Great Am. Ins. Co., 13 A.3d 1268 (Md. 2011), Maryland’s Supreme Court applied in the rule in the context of a claims-made policy.  Two subsequent Maryland federal district courts distinguished the holding in Sherwood when considering claims made and reported policies.  The court also noted the recent decision in McDowell Bldg., LLC v. Zurich Am. Ins. Co., 2013 U.S. Dist. LEXIS 132854 (D. Md. Sept. 17, 2013), where Maryland’s federal district court applied the rule in the context of a claims made and reported policy.

In considering these cases, the court focused heavily on the reasoning in Sherwood, in particular the Sherwood Court’s determination that the purpose of § 19-110 was to make “policy provisions requiring notice to, and cooperation with, the insurer covenants and not conditions.”  Accordingly, the court agreed that the rule articulated in Sherwood applies to all policies, including claims made and reported policies.  As such, the court determined that Navigators was required to demonstrate actual prejudice, by a preponderance of the evidence, in order to disclaim coverage under the 09-10 policy.

New York Court Holds Claimants Had No Standing to Sue Professional Liability Insurer

In its recent decision in Commonwealth Land Title Ins Co. v. American Signature Services, Inc., 2014 U.S. Dist. LEXIS 22172 (E.D.N.Y. Feb. 20, 2014), the United States District Court for the Eastern District of New York had occasion to consider when and under what circumstances a claimant can bring a direct action against an insurer.

Alterra insured American Signature, a title insurance agency, under a professional liability policy.  While the policy was in effect, American Signature was named as a defendant in a lawsuit brought by two title insurance companies for whom American Signature had been an agent.  Plaintiffs named Alterra as a direct defendant in their suit on the theory that they were third-party beneficiaries of the policy, and that as such, they were entitled to seek indemnification from Alterra directly.  In the alternative, plaintiffs sought a ruling that Alterra had a duty to defend and indemnify American Safety in connection with their lawsuit, as Alterra had denied any such obligation to American Signature, and in fact, had commenced its own coverage action against American Signature seeking a rescission of the policy or, in the alternative, a declaration that it had no coverage obligations in connection with the underlying suit.

Citing to Lang v. Hanover, 3 N.Y.3d 350 (N.Y. 2004), Alterra argued that under New York common law, an injured party has no direct cause of action against the insurer of a tortfeasor.  The Lang decision acknowledged that New York Insurance Law §3420(a) creates a limited exception to this rule by allowing claimants to bring a direct action against a tortfeasor’s insurer only after obtaining a judgment against the tortfeasor, and only then when the judgment “remains unsatisfied at the expiration of thirty days from the serving of notice of entry of judgment upon the attorney for the insured, or upon the insured, and upon the insurer … .”  In summarizing the Lang decision, the Eastern District explained that the New York Court of Appeals “determined that compliance with the requirements of Section 3420(a)(2) is a condition precedent to any direct action against the insurance company,” and that as such, “an injured third party has no cause of action against an insurer at common law, but may bring such an action under Section 3420 so long as the plaintiff has met the conditions set forth in Section 3420(a)(2).”

While plaintiffs conceded that they did not yet have a judgment against American Signature, they nevertheless argued that a direct action was permissible because the Alterra policy was not governed by New York Insurance Law §3420, which by its terms applies to policies “insuring against liability for injury to person … or against liability for injury to, or destruction of, property.”  Plaintiffs argued that as a professional liability policy, the Alterra policy was not one insuring bodily injury or property damage, and that as such, a direct action should be permitted.  The court rejected this argument, explaining that §3420 is not a limitation on direct actions, but rather an exception to the common law rule prohibiting such an action.  As the court explained:

… the New York Court of Appeals in Lang rejected this ap-proach, observing that New York common law does not recognize a third party's claim against an insurer because of the lack of privity between them, and that Section 3420 grants a limited statutory cause of action where one does not exist under the common law.

This common law rule, explained the court, is not limited to claims for bodily injury or property damage, but instead applies to any direct actions by claimants against the insurer of a tortfeasor, regardless of the nature of the underlying claim.  As such, the court concluded that it need not reach the issue of whether §3420 applied to the Alterra policy, since even if it did, a direct action could only proceed after a judgment.  In passing, the court noted that if §3420 did not govern the Alterra policy, then plaintiffs could never have a direct cause of action against Alterra under New York common law.   In passing, however, the court pointed to several New York decisions holding that the statute applies broadly to any policy issued or delivered in New York, not just ones insuring against bodily injury or property damage.

New York’s Highest Court Vacates Its Decision in K2

In its February 18, 2014 decision in K2 Investment Group, LLP v. American Guarantee & Liability Ins. Co., New York’s Court of Appeals – New York’s highest court – had occasion to revisit its prior ruling concerning the effect of an insurer’s breach of the duty to defend.

By decision dated June 11, 2013, the Court of Appeals seemingly articulated a new rule regarding the consequences of an insurer’s breach of the duty to defend.  K2 Inv. Group, LLC v. American Guar. & Liab. Ins. Co., 21 N.Y.3d 384 (NY 2013).  Specifically, the Court held that by having wrongfully denied a defense to its insured under a professional liability policy, American Guarantee “lost its right” to rely on certain policy exclusions for indemnity purposes.  Relying on its decision in Lang v. Hanover Ins. Co., 3 N.Y.3d 350 (NY 2004) – a case involving the insurer’s right to contest the insured’s liability for an underlying loss after breaching the duty to defend – the Court explained the new rule as follows:

… we now make clear that Lang, at least as it applies to such situations, means what it says: an insurance company that has disclaimed its duty to defend "may litigate only the validity of its disclaimer." If the disclaimer is found bad, the insurance company must indemnify its insured for the resulting judgment, even if policy exclusions would otherwise have negated the duty to indemnify.

The Court justified this rule on fairness grounds, explaining that:

This rule will give insurers an incentive to defend the cases they are bound by law to defend, and thus to give insureds the full benefit of their bargain. It would be unfair to insureds, and would promote unnecessary and wasteful litigation, if an insurer, having wrongfully abandoned its insured's defense, could then require the insured to litigate the effect of policy exclusions on the duty to indemnify. 

In so ruling, the K2 Court notably did not cite to its prior decision in Servidone Construction Corp. v. Security Ins. Co., 64 N.Y.2d 419 (NY 1985), wherein the Court held that an insurer’s breach of the duty to defend cannot operate to enlarge a policy’s coverage.  Thus, the decision in K2 stood in direct conflict with Servidone. 

Following the Court’s June 11, 2013 decision, American Guarantee moved for reargument, primarily on the basis that the Court failed to address the decision in Servidone, and thus created an inconsistency in the case law.  The Court granted American Guarantee’s motion for reargument – a relief afforded by the Court of Appeals on only rare occasions – and a second round of oral argument was held on January 7, 2014.

In its February 18, 2014 decision, Judge Robert Smith, writing for a four-judge majority (two judges dissented and one judge abstained) acknowledged that the Court’s June 11, 2013 holding was irreconcilable with its prior decision in Servidone.  While the Court reaffirmed its prior holding in Lang that an insurer is not permitted to relitigate issues in the underlying case if it breaches its duty to defend, the Court recognized that this issue is distinct from whether an insurer is permitted to litigate its indemnity obligation subsequent to a wrongful denial of its duty to defend.

In so holding, the Court noted that “[t]here is much to be said for the rule” it articulated in its initial June 11^th decision.  The Court nevertheless acknowledged that the majority of jurisdictions follow the Servidone rule – the principle exceptions being Illinois and Connecticut.  The Court further observed that K2 failed to present “any indication that the Servidone rule has proved unworkable, or caused significant injustice or hardship, since it was adopted in 1985.”  Under the circumstances, the Court found it preferable to follow its prior holding in Servidone, explaining:

When our Court decides a question of insurance law, insurers and insureds alike should ordinarily be entitled to assume that the decision will remain unchanged unless or until the Legislature decides otherwise. In other words, the rule of stare decisis, while it is not inexorable, is strong enough to govern this case.

With this in mind, the Court turned to the application of the policy exclusions, and concluded that these exclusions presented a sufficient question of fact to defeat K2’s underlying motion for summary judgment.

Writing for a two-judge dissent, Judge Victoria Graffeo expressed her belief that an insurer should be penalized for breaching the duty to defend.  In her opinion, Servidone should be limited to questions of coverage “in the first instance,” i.e., whether a loss falls within a policy’s insuring agreement.  While she agreed that an insurer that breaches a duty to defend should not be made to indemnify a loss not falling within the scope of a policy’s insuring agreement (i.e., “a homeowner's policy would not provide malpractice liability coverage”), she reasoned that this rule should not apply to policy exclusions. As she explained, “[p]rohibiting exclusions from being collaterally invoked provides an insurer with an incentive to appear on behalf of the policyholder in the underlying lawsuit, as it agreed to do in return for the payment of premiums.”

With the Court of Appeals’ decision to vacate its earlier ruling in K2, New York now returns comfortably to the majority rule that acknowledges an insurer's right to contest its indemnity obligation is separate and apart from any issue of its duty to defend.

New York’s Highest Court Holds Limitation on Suit Provision Unreasonable

In its recent decision in Executive Plaza, LLC v. Peerless Ins. Co., 2014 NY Slip Op 898, 2014 N.Y. LEXIS 165 (N.Y. Feb. 13, 2014), the Court of Appeals of New York, New York’s highest court, on a question certified from the United States Court of Appeals for the Second Circuit, had occasion to consider the enforceability of a policy provision restricting the time in which an insured could bring suit against the insurer.

Peerless insured Executive Plaza under a fire loss policy that provided $1 million in coverage for “actual cash value” or “replacement cost.”  The policy conditioned coverage on the lost or damaged property first being repaired or replaced, and that such repairs and replacements be made “as soon as reasonably possible after the loss or damage.”  The policy also contained a clause titled “Legal Action Against Us,” which stated, in pertinent part, that no suit could be brought under the policy unless the “action is brought within 2 years after the date on which the direct physical loss or damage occurred.”

Following a fire loss, Peerless paid Executive Plaza approximately $758,000 in actual cash value.  Executive Plaza subsequently notified Peerless that it would be seeking the balance of the policy’s limits in replacement costs.  In response, Peerless advised Executive Plaza that to be entitled to reimbursement for any replacement costs, it would need to submit documentation verifying completion of the repairs.  Executive Plaza claims that it undertook reasonable efforts to perform such repairs, but that it was not able to do so within two years of the fire that caused the loss.  In fact, Executive Plaza was not able to complete the repairs until nearly three years and eight months after the fire.  At that time, Executive Plaza sought reimbursement for the replacement costs under the policy.  Peerless denied coverage for the costs on the ground that the two-year limitation period had expired. 

In the ensuing coverage litigation, the United States District Court for the Eastern District of New York granted Peerless’ motion to dismiss on the basis of the “Legal Action Against Us” clause, noting “that the two-year limitation period in the Policy is reasonable, as New York Courts have consistently upheld two-year limitations periods in insurance contracts as reasonable.”  The matter was appealed to the Second Circuit, which in turn certified the question:

If a fire insurance policy contains

(1) a provision allowing reimbursement of replacement costs only after the property was replaced and requiring the property to be replaced ‘as soon as reasonably possible after the loss’; and

(2) a provision requiring an insured to bring suit within two years after the loss;

is an insured covered for replacement costs if the insured property cannot reasonably be replaced within two years?

In considering the issue, the Court of Appeals noted its own prior case law allowing for a contractual modification of a statute of limitations.  In fact, the Court had previously upheld “time to sue” periods in insurance policies of even shorter durations.  The guiding principle in these cases, explained the court, is whether the limited time period is reasonable under the circumstances.  With this in mind, the court focused on the issue of whether it was reasonable to expect that an insured, within two years of  a fire, could be able to repair and replace all damaged property.  The Court concluded that the two-year period was not necessarily unreasonable, but that the accrual date for the two-year period was.  As the Court explained:

It is neither fair nor reasonable to require a suit within two years from the date of the loss, while imposing a condition precedent to the suit — in this case, completion of replacement of the property — that cannot be met within that two-year period. A "limitation period" that expires before suit can be brought is not really a limitation period at all, but simply a nullification of the claim. It is true that nothing required defendant to insure plaintiff for replacement cost in excess of actual cash value, but having chosen to do so defendant may not insist on a "limitation period" that renders the coverage valueless when the repairs are time-consuming.