Washington Court Holds Insurer Not Entitled to Reimbursement of Defense Costs

The Court of Appeals for the State of Washington, in its recent decision National Surety Corp. v. Immunex Corporation, 2011 Wash. App. LEXIS 1695 (Wash. App. July 25, 2011), had occasion to consider whether an insurer is entitled to recoupment of defense costs incurred prior to receiving a judgment declaring that it owed no duty to defend.

National Surety insured Immunex under an umbrella and excess liability policy.  Immunex was named as a defendant in a number of suits alleging that it participated in a conspiracy with other prescription drug manufacturers to artificially inflate the average wholesale price of its products.  While the first of the suits was filed in 2001, Immunex did not provide first notice of the suits to National Surety until 2006.  National Surety initially denied coverage based on late notice, but later agreed to provide a defense under a reservation of rights and to seek a declaratory judgment.  Among other things, National Surety reserved its right to recoup defense costs paid in the event it was determined that National Surety had no duty to defend.

Both the trial court and the appellate court agreed that the underlying suits filed against the insured, alleging price discrimination arising out of the insured’s alleged participation in the fraudulent pricing scheme, did not constitute “personal and advertising injury” under the policy, which included the offense of “discrimination.”  While the term “discrimination” was not defined by National Surety’s policy, the appellate court agreed that the underlying suits “originate[d] not from discriminatory actions but from fraudulently inflating” the price of its products.  Although this conduct “might have impacted some consumers more than others, that does not mean the offenses originated from discrimination.”  Thus, the court agreed that National Surety did not have a duty to defend the underlying suits.

While the court held that National Surety had no duty to defend, it disagreed that National Surety was entitled to recoupment of defense costs it had already incurred. The court acknowledged that lack of Washington case law on the issue, but found guidance from the line of cases holding that an insurer has a duty to defend whenever a complaint alleges a potentially covered claim.  While it was ultimately determined that National Surety had no duty to defend, there was no certainty of that outcome until the trial court ruled in National Surety’s favor.  Accordingly, National Surety had a duty to defend from the time the underlying complaint was filed through the time it received summary judgment in the coverage litigation, and as such, it was proper for National Surety to pay defense costs during that period.

The court addressed at length an insurer’s options when it is not clear from the face of the pleading as to whether a defense obligation is triggered.  Under such circumstances, the insurer can deny coverage outright or provide a defense under a reservation of rights and seek a declaratory judgment.  By providing a defense under a reservation of rights, the insurer avoids the potential for having breached any subsequently determined defense obligation.  By opting for the latter, explained the court, the insured is not unjustly enriched by receiving a defense:

… National Surety had the benefit of insulating itself from a bad faith claim and possible coverage by estoppel.  Therefore, the payment of the defense costs is not purely a gratuity to the insured and no unjust enrichment occurs if National Surety covers the cost of defense until the trial court ordered otherwise.

Thus, the court held that an insurer’s reservation of rights to recoup defense costs will not be enforced absent express language in the policy allowing for such relief.

South Dakota Supreme Court Addresses Sudden and Accidental Pollution Exclusion Language

In its recent decision in Demaray v. De Smet Farm Mut. Ins. Co., 2011 S.D. LEXIS 98 (S.Dak. July 20, 2011), the South Dakota Supreme Court addressed whether the phrase “sudden and accidental,” as used in a pollution exclusion, is ambiguous.

The insureds, who ran a cattle operation, were sued for alleged intermittent, repeated and continuing discharge of animal and other wastes and process waste water into lakes and streams on the claimant’s property.  The insureds sought coverage under the liability coverage of a policy issued by De Smet Fam Mutual Insurance Company.  De Smet, in turn, denied coverage on the basis of the policy’s pollution exclusion applicable to the “the discharge, dispersal, release, or the escape of pollutants into or upon land, water or air.”  The exclusion, however, contained an exception for “bodily injury or property damage arising out of the sudden and accidental discharge, dispersal, release or escape into or upon land . . . of pollutants used in or intended for use in normal and usual farming activities[.]”  The insureds argued that the exception applies because the pollution alleged in the underlying complaint failed to allege that the pollution was the result of intentional conduct.

The court acknowledged that matter was one of first impression as no South Dakota court previously addressed the phrase “sudden and accidental” in the context of a pollution exclusion.  The court therefore looked to the two lines of “sudden and accidental” case law in other jurisdictions.  The first line of cases holds that the phrase “sudden and accidental” is ambiguous since the word sudden can have several meanings, including accidental and abrupt.  In light of this ambiguity, these courts construe the phrase in the insured’s favor to mean accidental, and as such, the phrase “sudden and accidental” means “unexpected or unintended.”  By contrast, the other line of cases holds that the phrase is unambiguous and that the term “sudden” refers solely to a temporal element.  The court agreed with the latter line of cases.

Thus, agreeing that the phrase “sudden and accidental” has a temporal element, the court looked to the allegations in the underlying complaint to determine whether any of the alleged discharges could be describe as “abrupt or immediate and unexpected or unintended.”  The court held that no such conduct was alleged.  Rather, the underlying complaint alleged intermittent and continuous discharges which the court explained was not “sudden and accidental”:

No language in the Alvine complaint arguably supported a cause of action for a "sudden and accidental" discharge of pollutants. "Intermittently" cannot be construed to mean abrupt or immediate. The complaint clearly made claims against Demaray and Hagemann for "past and continuing" and "repeated" discharges that "will continue." There is no immediacy or abruptness with a discharge that is intermittent, repeated, and likely to continue.

The court further rejected the insureds’ attempt to point to single “sudden and accidental” events within the larger course of systemic conduct, such as a sudden and violent rainstorm that caused waste to be discharged onto the claimant’s property.  The court explained that it would not engage in “microanalyzing” the insureds’ long-term routine of waste disposal in order to find one single, discrete instance of a “sudden and accidental” discharge. 

Fifth Circuit Agrees: Duty to Indemnify Broader than Duty to Defend Under Texas Law

In D.R. Horton-Texas, Ltd. v. Markel Int’l Ins. Co., 300 S.W. 3d 740 (Tex. 2009) and Burlington Northern & Santa Fe Railway Co. v. Nat'l Union Fire Ins. Co., 334 S.W.3d 217 (Tex. 2010), the Texas Supreme Court established the rule that an insurer can have a duty to indemnify even in the absence of a corresponding duty to defend.  The United States Court of Appeals for the Fifth Circuit recently addressed this concept in Colony Ins. Co. v. Peachtree Construction, Ltd., 2011 U.S. App. LEXIS 14740 (July 19, 2011).

Peachtree was a general contractor hired by the State of Texas for a highway-repaving project.  Peachtree contracted with a third party, CrossRoads, to provide construction signs, barricades and warning devices.  Pursuant to this contract, CrossRoads was required to name Peachtree as an additional insured under its primary and excess liability policies.   Colony was CrossRoads’ primary liability carrier.

Peachtree was later sued in a wrongful death action arising out of a motorcycle crash that happened at the construction site. While the suit alleged that Peachtree failed to use proper signage and warnings, CrossRoads was not named as a defendant nor did it contain any allegations concerning CrossRoad’s negligence.  Peachtree tendered the matter to CrossRoad’s insurers.  Colony provided Peachtree with a defense under a reservation of rights, but commenced a declaratory judgment action, arguing that it had no duty to defend or indemnify since the underlying matter did not allege negligence on the part of CrossRoads. The federal district court granted summary judgment in favor of Colony, holding that because the underlying suit did not allege any negligent arising out of CrossRoads’ work, Colony had no duty to defend Peachtree, and as such, it could not have a duty to defend.

Peachtree did not appeal the aspect of the district court’s concerning the duty to defend.  Rather, its appeal was limited to the issue of whether in light of the D.R. Horton decision (the matter apparently was briefed before the Burlington Northern decision), Colony could have a duty to indemnify even though its defense obligation was not triggered.  The Fifth Circuit, citing to D.R. Horton, agreed that indemnity obligation could arise even in the absence of a defense obligation, explaining that under Texas law, the duty to indemnify is not subordinate to the duty to defend and, in fact, requires a separate factual analysis.  Even though the underlying suit did not contain any allegations concerning CrossRoads’ own negligence that would trigger a defense obligation, the district court was still required to consider whether Colony had a duty to indemnify.  As the Fifth Circuit explained, “[w]here there has been an underlying trial on the issue of liability, the facts adduced at trial might differ from the allegations, and thus, a duty to indemnify could be shown notwithstanding the absence of a duty to defend.”  Thus, the lower court was required to consider any factual evidence offered by Peachtree, including evidence extrinsic to the underlying complaint, to determine whether the accident arose out of CrossRoads’ work performed on behalf of Peachtree such that Colony’s indemnity obligation was triggered.

Seventh Circuit Affirms Cost of Capital Improvements Not Covered Under GL Policy

In its recent decision, Continental Cas. Co. v. Sycamore Springs Homeowners Association, 2011 U.S. App. LEXIS 15005 (July 22, 2011), the United States Court of Appeals for the Seventh Circuit, applying Indiana law, had occasion to consider whether an underlying suit demanding that the insured undertake measures to prevent future “property damage” triggered coverage under a general liability policy.

The insured, Courtyard Homes, was the developer of a residential subdivision constructed in a flood plain in Indianapolis, Indiana.  In fact, both Courtyards Homes, and the homeowners’ association, Sycamore Springs, knew of the flood risks associated with the area.  Courtyard Homes addressed this risk by constructing various flood-protection elements such as levees and retention ponds.  It was alleged, however, that Courtyard Homes overdeveloped the property, placing too much strain on these preventative measures, and that as a result, they failed during an extended period of heavy rains.

Sycamore Springs later sued Courtyard Homes, but not for damage resulting from the flooding.  Rather, Sycamore Springs sought relief in the form of requiring Courtyard Homes to construct improved measures to reduce the chances of future flooding.  Courtyard Homes’ carrier, Continental, denied coverage primarily on the basis that “any loss was the expected result of a deliberate reduction in the subdivision's ability to deal with heavy rain or a rising river” and thus did not allege "property damage" arising out of an occurrence.  In the ensuing coverage action, the district court did not reach the issue of whether the underlying suit alleged an occurrence.  Rather, the court found in favor of Continental on the basis that the suit did not allege loss arising out of “property damage,” but instead sought  to prevent future “property damage.”  Costs associated with preventing future, hypothetical “property damage,” held the court, did not fall within the policy’s coverage. 

On appeal, the Seventh Circuit affirmed the lower court’s decision, and in doing so, rejected the insured’s argument that costs of capital improvements can qualify for coverage under a liability policy.  The court reasoned that the moral hazards involved would prevent general liability insurers from writing such coverage:

Protected by a policy covering the costs of improvements, a builder would produce a substandard project and demand that the insurer finish the job; builder and buyers could split the savings. Insurers, recognizing this incentive, would raise the price of their policies so high that no builder planning to do the job right would find the offer attractive. The result would be the collapse of the insurance market. No one would gain, and honest builders would lose because insurance would no longer be available. That's why Continental's policy does not cover the expense of improving the subdivision's flood defenses.

Thus, held the Seventh Circuit, because the underlying suit did not involve any amounts that could be considered covered “property damage,” the lower court’s ruling was proper.  The Seventh Circuit nevertheless considered and rejected Continental’s argument that the underlying matter did not allege an “occurrence,” explaining that the unintended and unanticipated consequence of an intentional choice (i.e., constructing a housing development in a flood zone without proper precautions) can be an accident for the purpose of a liability policy.  Notwithstanding, a general liability policy provides coverage only for “property damage” resulting from such an accident, not for costs associated with preventing future “property damage.”

California Court Holds Groin Punch Not an Occurrence

The California Appellate Court for the Second Appellate District recently issued a ballsy decision that can only be described a low blow to insureds.  In State Farm General Ins. Co. v. Frake, 2011 Cal. App. LEXIS 911 (Cal. App. July 13, 2011), the court was asked to consider whether the insured’s intentional battery of his friend’s nether regions constituted an “occurrence” for the purpose of a renter’s liability policy.

The fracas in Frake reads like an episode of Jackass.  The insured, Frake, was visited by two former high school classmates in Chicago for a weekend of “partying and drinking” to be highlighted by a Cubs game.  These friends, immune to all fears of future fertility, enjoyed the age-old tradition of sucker punching each other in the groin which, to be frank, is best described by the court:

Frake explained that, since high school, his friends had engaged in “a cycle of horseplay[,] specifically … hitting each other in the groin.” During this “consensual” ritual, one person would normally try to “slap or hit [another person] in … the groin area,” and the recipient would then “attempt to return [the slap or hit].” According to Frake, the practice was so common that his friends would “greet each other with a one arm hug,” while covering their “groin area” with the other arm for “protection in case [someone] decided to … instigate th[e] horseplay.”

That weekend, after enjoying a ballgame of a more traditional  sort at Wrigley Field, and after all involved had consumed excessive amounts of alcohol, King attempted to punch Frake’s “friends,” but his aim was wide and his hand redirected  by Frake.  Having protected his flank, Frake fisted his former friend in the front, lending new meaning to taking the King’s bishop.  King later sued Frake alleging that “Frake deliberately struck King in the groin,” although the complaint did not contain any allegations as to whether Frake intended injury.  King was eventually awarded $400,000 for injuries way too painful for these authors to describe.

State Farm provided Frake with a defense under a reservation of rights, but later commenced a declaratory judgment action on the issue of whether the underlying suit alleged an “occurrence,” defined by the policy as an accident. Frake argued that that while he intended to strike his buddy’s bullocks, he did not intend to cause harm, and as such, his conduct should not be considered anything but accidental.  The court’s response to this argument can best be described as testy.  The court rejected the concept that the consequences determines whether one’s conduct is an accident, explaining:

The language of the policy at issue here, which is the same language used in most standard liability policies, supports the conclusion that the term “accident” refers to the insured's conduct, rather than the unintended consequences of that conduct. The policy provides coverage for “bodily injury … caused by an occurrence.” The term “occurrence” is defined as “an accident.” Therefore, under the policy, “an ‘occurrence’ is a causal event, defined as an ‘accident.’ In this context, an ‘accident’ cannot mean unintended damage because the causal event also would be the result. Logically, a consequence cannot cause itself.”  (Citations omitted.)

Moreover, the court rejected the insured’s arguments that the decision by the California Supreme Court in Delgado v. Interinsurance Exchange of Automobile Club of Southern California, 47 Cal. 4th 302 (Cal. 2009) and by the Second Appellate Division in State Farm Fire & Casualty Co. v. Superior Court, 164 Cal. App. 4th 317 (Cal. App. 2008) dictated the result that unintended consequences of an intentional act constitute an “occurrence” for the purpose of a liability policy.  These cases, explained the court, are consistent with the notion that absent “an intervening act of fortuity,” it is the injury-producing act that is dispositive of whether an occurrence happened.  Thus, cocksure of its decision, each member of the court ruled that State Farm did not owe a duty to defend or to indemnify Frake under the policy. 

EDS. NOTE: FOR OBVIOUS REASONS, THE IDENTITY OF THE AUTHORS OF THIS POST SHALL REMAIN CONFIDENTIAL.

Connecticut Court Holds Insurer Not Entitled to Recoupment of Defense Costs

In Security Ins. Co. of Hartford v. Lumbermans Mutual Casualty Co., 826 A.2d 107 (Conn. 2003), the Connecticut Supreme Court held that when an insurer “defends the insured against an action that includes claims not even potentially covered by the insurance policy, a court will order reimbursement for the cost of defending the uncovered claims in order to prevent the insured from receiving a windfall.”  The United States District Court for the District of Connecticut recently had occasion to address the bounds of this rule in Nationwide Mutual Ins. Co. v. Mortensen, 2011 U.S. Dist. LEXIS 77356 (D. Conn.  July 18, 2011).

The insureds in Nationwide were former insurance agents for Nationwide and its affiliated companies.  These individuals also happened to be insured by Nationwide under Business Provider Insurance Policies.  In the underlying suits, Nationwide sued the individuals on several grounds, including breach of contract, breach of fiduciary duty, unfair trade practices and trademark infringement.  These individuals, in turn, sought coverage for the underlying suits under their Nationwide policies.  Nationwide agreed to provide a defense subject to a reservation of rights, including the right to seek recovery of defense costs associated with non-covered claims.  It subsequently filed coverage litigation action against the insureds and successfully obtained a declaratory judgment that it had no coverage obligation with respect to the underlying suits.  In a 2009 decision, however, the court held that Nationwide was not entitled to reimbursement of defense costs incurred prior to the declaratory judgment, explaining that:

It was in Nationwide's own interest to provide a defense under the reservation of rights in order to avoid exposure had the Court held it did have a duty to defend. If the Court were to now allow Nationwide to recoup defense costs, the defendants would be required to pay for the action Nationwide took to protect itself. In these circumstances, in the absence of a policy provision pointed to by Nationwide or active assent to the reservation by the defendants, the reservation of rights letters were not enough to impose a burden on the defendants to reimburse Nationwide for defense costs.  Nationwide Mut. Ins. Co. v. Mortensen, 2009 U.S. Dist. LEXIS 74870 at *18-19 (D. Conn. Aug. 24, 2009).

Nationwide subsequently moved for reconsideration, arguing that decision by the Connecticut Supreme Court in Security Ins. Co. established a general rule that an insurer could recover defense costs associated with non-covered claims.  The Nationwide court disagreed with Nationwide, explaining that Security Ins. Co. should be limited to its facts.  The Security Ins. Co. matter concerned an insured’s asbestos liabilities over a seventeen-year period, several years of which it was uninsured.  The Connecticut Supreme Court held that in light of Connecticut’s pro rata methodology for allocating defense costs, the insured should be required to pay its prorated share of the defense for uninsured periods.  As such, the insurers were entitled to reimbursement of defense costs they had already paid for these periods.  The Nationwide court reasoned that recoupment of defense costs was proper in Security Ins. Co., since there was no potential for coverage in the uninsured periods.  By contrast, explained the court, while it was determined that the underlying suits brought by Nationwide were not covered, “there was at least a potential that the defendants’ claims would be covered.”  (Emphasis in original.)   Given this potential, explained the court, “Nationwide had a temporary duty to defend until a determination on coverage was made,” and as such, it would be improper for Nationwide to recoup its defense costs incurred during this period.

Eleventh Circuit Holds Repair of Insured’s Work Not Covered Property Damage

In its recent decision Palm Beach Grading, Inc. v. Nautilus Ins. Co., 2011 U.S. App. LEXIS 14576 (11^th Cir. July 14, 2011), the Eleventh Circuit affirmed a holding by the United States District Court for the Southern District of Florida that costs associated with repair of the insured’s own work does not constitute “property damage” under a general liability policy.

The insured, A-1 Underground, had been subcontracted to construct water utilities and sanitary sewer utilities in connection with a larger construction project.  A-1 later abandoned the project, forcing the general contractor, Palm Beach Grading (“PBG”) to hire a second subcontractor to complete the work.  The second subcontractor determined that A-1’s work associated with a sewer line was defective, requiring the subcontractor to dig up and replace the line.  PBG later sued and obtained a judgment against A-1.  PBG then commenced suit against A-1’s general liability carrier, Nautilus, seeking recovery of the repair costs.

The Eleventh Circuit acknowledged that under Florida law, faulty work can constitute an “occurrence.”  The court nevertheless agreed with the lower court that the repair costs associated with A-1’s faulty work did not constitute third-party property damage as required under the policy.  In so holding, the Eleventh Circuit relied on the decisions by the Florida Supreme Court in U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So.2d 871 (Fla. 2007) and Auto-Owners Ins. Co. v. Pozzi Window Co., 984 So.2d 1241 (Fla. 2008), in which the courts concluded that a general liability policy only covers the costs of repairing damage resulting from an insured’s defective work, not the cost of repairing the or removing the defective work itself.  Because PGB’s claim was limited to repairing the sewer line, as opposed to damage caused by the sewer line (such as resulting sinkholes or back-ups), the underlying suit did not allege “property damage” triggering coverage under the Nautilus policy.

Sixth Circuit Holds Supplier is a Subcontractor Under Business Risk Exclusion

In its recent decision Mosser Constr. v. Travelers Indem. Co., 2011 FED App. 0481N (6^th Cir. July 14, 2011), the United States Court of Appeals for the Sixth Circuit, applying Ohio law, had occasion to consider what constitutes a “subcontractor” for the purpose of a “your work” exclusion in a general liability policy. 

The insured, Mosser, was a general contractor hired to construct an addition to a waste water facility plant.  As part of its work, Mosser was required to place structural backfill beneath and around the new building.  The contract specifically required that Mosser use backfill meeting the size and grading requirements for AASHTO #57 coarse aggregate.  Mosser contracted with a supplier for the purchase of the required fill, which the supplier happened to have available in stock. The supplier never visited the construction site and, in fact, was not even involved in the delivery of the fill to the site.  The backfill ultimately proved to be defective, resulting in damage to the newly constructed facility.

Mosser’s general liability carrier, Travelers, denied coverage for the resulting property damage claim made against Mosser based on a standard “your work” exclusion applicable to:

l.          Damage To Your Work

"Property damage" to "your work" arising out of it or any part of it and included in the "products-completed operations hazard".

The exclusion, however, is subject to the following standard exception:

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

Mosser argued that the exception applied to the exclusion since the supplier of the fill should be considered a subcontractor.  Travelers, on the other hand, argued that subcontractor has a well-understood meaning within the construction industry that is typically limited to contractors that actually perform work on a project.  As such, argued Travelers, a supplier of materials to be used in a construction project cannot qualify as a subcontractor.

Noting that no Ohio court had addressed the definition of subcontractor for the purpose of the “your work” exclusion, the Sixth Circuit looked to case law in other jurisdictions.  The court acknowledged that several courts had concluded that a material supplier can qualify as a subcontractor when that supplier fabricates the purchased material to some degree of customization, or otherwise performs some work on site.  In other words, a supplier must do something more than merely provide standard inventory items. 

In light of this case law, the Sixth Circuit concluded that the undefined term “subcontractor” was ambiguous and therefore must be construed in a manner most favorable to Mosser.  The court, however, refused to draw a bright line, as argued by Mosser, that all suppliers of material are necessarily subcontractors.  For example, explained the court, a hardware store selling standard-inventory nails is not a subcontractor.  Rather, when a supplier does not perform any actual work on site, it will be considered a subcontractor only when it “must manufacture the material according to specifications supplied by the general contractor, and, its materials contract with the general contractor must explicitly incorporate terms from the master contract or otherwise explicitly indicate that the materials at issue are manufactured or supplied specifically for the master contract's project.”

Turning to the specific facts in Mosser, the court concluded that while the supplier happened to have the requested fill in stock, such was a mere coincidence and that the supplier would have had to custom fabricate such fill had it not been in stock.  Just as significant for the court was the fact that the purchase order entered into between Mosser and the supplier specifically referenced the underlying general contract for which the fill would be required.  Thus, “[a]lthough [the supplier] may have produced all or part of the backfill before entering into the purchase order with Mosser, the circumstances of this case are enough to nudge [the supplier] over the line separating mere material suppliers from subcontractors.”

While the Mosser court was careful to avoid the bright-line advocated by the insured, i.e., that all suppliers are subcontractors, the court’s decision nevertheless has the potential to have significant insurance coverage ramifications, both in terms of the business-risk exclusions as well as for additional insured issues.

D.C. Court Holds No Prejudice Resulting From Insurer’s Control of Defense

In its recent decision in Capitol Specialty Ins. Corp. v. Sanford Wittels & Heisler, LLP, 2011 U.S. Dist. LEXIS 68171 (D.D.C. June 27, 2011), the United States District Court for the District of Columbia had occasion to consider whether the insurer, as a result of its actions, was estopped from denying coverage to its insured.

The policy at issue in Capitol Specialty was a lawyers’ professional liability policy issued to a firm that was sued for malpractice in connection with its prosecution of a class action.  The insurer, Capitol Specialty, agreed to provide the firm with a defense in the malpractice suit under a reservation of rights.  While the insured initially selected defense counsel of its own choice, Capitol Specialty subsequently exercised its right under the policy to pick counsel.  In doing so, Capitol Specialty specifically advised that if the insured did not want to cede control of the defense, Capitol Specialty would “disengage counsel and close this matter.”  Capitol Specialty’s letter regarding selection of counsel reiterated its earlier reservation of rights.  Nearly seven months later, Capitol Specialty denied coverage for the matter based on the policy’s prior knowledge exclusion.

In a subsequent declaratory judgment action, Capitol Specialty was successful in showing that the exclusion operated to preclude coverage.  The insured, however, argued that Capitol Specialty was estopped from denying coverage after having controlled the defense.  The court noted that while Capitol Specialty did control the insured’s defense, it did so under a proper reservation of rights.  Under the circumstances, explained the court, estoppel will lie only where the insured can show that it was actually prejudiced as a result of the insurer’s conduct.  Such prejudice could be shown by demonstrating that the insurer’s control of the defense harmed or hindered the insured by undermining its ability to defend itself.

The insured argued that Capitol Specialty was estopped from denying coverage because: (1) it initially advised that coverage was available for the underlying suit; (2) it assumed the defense of the underlying suit; (3) it waited too long before disclaiming coverage and (4) it prejudiced the insured’s defense.  The court easily rejected the first three points, explaining that these arguments were “not evidence of prejudice” in light of Capitol Specialty’s proper reservation of rights.  Turning to the fourth point, the court held that the insured failed to demonstrate that it had been actually prejudiced.  While Capitol Specialty did cause the insured to terminate its initial counsel, the court explained that this would be prejudicial only if the insured could demonstrate that counsel selected by the insurer performed demonstrably worse than preferred counsel would have performed.  Because the insured alleged no facts of “poor representation or malpractice” and because the insured never objected to Capitol Specialty’s conditional defense, the court concluded that the insured failed to show that it had been prejudiced.

Michigan Court Holds No Coverage Under Successive UST Policies

In its recent decision Webb Operating Co. v. Zurich American Ins. Co., 2011 U.S. Dist. LEXIS 73675 (E.D.Mich. July 8, 2011), the United States District Court for the Eastern District of Michigan had occasion to consider whether an insured under a series of consecutive claims made and reported underground storage tank policies was entitled to coverage for remediation costs where it failed to report the “claim” during the proper policy period.

The policies at issue insured a gas station operated by the insured for cleanup costs as required by governmental authorities resulting from releases from covered underground storage tanks, but only to the extent discovered during the policy period and only to the extent the “claim” was reported to Zurich during the policy period.  The relevant policy defined “claim” as notice given by the insured, during the “policy period” seeking payment of “cleanup costs” required by a “governmental authority.”  The preamble to the policies expressly identified the policies as “claims made and reported” policies.

During the period the insured’s 2005-2006 policy was in effect, one of its covered underground storage tanks failed a tank tightness test.  The insured subsequently decided to close its tank, but chose not to report the matter to Zurich at the time because the costs associated with the tank closure barely exceeded the policy’s deductible.  The insured, however, continued to incur monitoring and remediation costs over the next three years, ultimately leading to its decision to give notice to Zurich when its policy for the 2009-2010 period was in effect.  The insured argued that coverage should be afforded under the 05-06 policy, or at the very least, under the 09-10 policy, since that was when it gave notice of claim.  Among other things, the insured argued that Zurich could not disclaim coverage under the 05-06 policy unless it could show it had been prejudiced as a result of the insured’s delayed notice.

The court rejected the insured’s prejudice argument, explaining that prejudice is a consideration only with respect to occurrence-based policies, not claims made and reported policies.   Because the Zurich policies were claims made and reported policies, wrote the court, Zurich was not required to show that it was prejudiced under the 05-06 policy in order to disclaim coverage.  Rather, Zurich only needed to show that the insured failed to comply with the policy’s condition precedent to coverage; namely, giving notice of “claim” during the same policy period in which the release was first discovered.  The court concluded for the same reason that coverage was unavailable under the 09-10 policy since the release was not first discovered during the time that policy was in effect.