New York’s Highest Court Addresses Coverage Under Fiduciary Liability Policy

In its recent decision in Federal Ins. Co. v International Bus. Machs. Corp., 2012 NY Slip Op 1320 (N.Y. Feb. 21, 2012), the New York Court of Appeals - New York’s highest court - had occasion to consider whether an underlying ERISA lawsuit fell within the scope of coverage afforded under an excess fiduciary liability policy, and in particular, what it means to be acting in one’s capacity as a fiduciary.

Federal issued to IBM an Executive Protection Excess Insurance Policy, providing follow-form excess coverage over a fiduciary liability policy issued by Zurich.  IBM and the IBM Personal Pension Plan were named as defendants in a class action lawsuit alleging that various amendments made to its employees’ benefit plans violated ERISA laws pertaining to age discrimination.  IBM settled the underlying suit, which settlement included a payment to plaintiffs of their attorneys’ fees in prosecuting the lawsuit.  IBM, in turn, sought coverage for the payment of these fees under the Federal policy, claiming that the primary Zurich policy, with limits of liability of $25 million, had exhausted. 

Federal sought a judicial declaration that coverage was unavailable for the underlying suit as it did not fall within the Zurich policy’s definition of “wrongful act,” which was amended by endorsement to include:

1.      any breach of the responsibilities, obligations or duties by an Insured which are imposed upon a fiduciary of a Benefit Program by the Employee Retirement Income Security Act of 1974, as amended, or by the common or statutory law of the United States, or ERISA equivalent laws in any jurisdiction anywhere in the world;

2.      any other matter claimed against an Insured solely because of such Insured's service as a fiduciary of any Benefit Program;

3.      any negligent act, error or omission in the administration of any Benefit Program.

Federal argued that the underlying ERISA class action did not fall within this definition of “wrongful act” because the suit was not brought against IBM in its capacity as a fiduciary but rather in its capacity as a plan settlor or sponsor.  While the trial court rejected Federal’s argument, this ruling was reversed on appeal by a New York intermediate court, which agreed that “[t]he age discrimination provisions of ERISA, which IBM allegedly violated by enacting the amendments, are not responsibilities, obligations, or duties imposed upon a fiduciary of a Benefit Program by ERISA. Rather, they are obligations imposed on settlors of ERISA benefit plans.”

On further appeal, the Court of Appeals agreed with the Appellate Division that the changes IBM made to the benefit plans were made in its capacity as a plan settlor rather than in a fiduciary capacity.  The Court further agreed that the definition of “wrongful act” limited coverage to instances where the insured is acting in a fiduciary capacity.  As the Court explained, “[w]e conclude that the average insured would reasonably interpret the disputed language in the definition of ‘Wrongful Act’ to mean that coverage is limited to acts of an insured undertaken in its capacity as an ERISA fiduciary.”

In reaching its conclusion, the Court rejected several arguments asserted by IBM.  Most notably, IBM argued that because the term “fiduciary” was not defined in the Zurich policy, it must be given a “plain, ordinary meaning” that the average policyholder would understand rather than the definition contained in the ERISA statute.  Specifically, IBM argued that the term “fiduciary” should be construed as one who acts for the benefit of another and owes that party the duties of good faith – duties that IBM owed to underlying plaintiffs as the plan sponsor.  Under this interpretation of the term “fiduciary,” explained the Court, “IBM's actions would be covered by virtue of the fact that it was an insured and a plan fiduciary that allegedly violated certain ERISA provisions, regardless of the fact that, if the allegations are correct, it undoubtedly did so in its capacity as a plan settlor and not in its capacity as an ERISA fiduciary.”  The Court rejected this broad construction of the term “fiduciary,” explaining that it would result in a “strained and implausible” interpretation of the policy.  As the Court explained, because “the first prong of the ‘Wrongful Act’ definition refers not only to duties imposed by ERISA (or foreign equivalents) but also to duties imposed by common law and statutory law,” IBM’s proposed definition of fiduciary would result in the policy extending coverage to “almost every lawsuit imaginable, a result we find to be unreasonable.”

The Court also considered IBM’s argument that under Federal’s interpretation of the policy, the first and second prongs of the definition of “Wrongful Act” would have an identical meaning.  The Court rejected this argument, explaining that the first prong related to violations of ERISA or other common or statutory law, whereas the second prong related to any fiduciary breach.  As the Court explained, “[p]rong two would extend coverage to an insured's claims arising from liability incurred solely due to the insured's position as a fiduciary. For instance, if the insured is named in an action solely due to its status as a fiduciary, even where the action does not allege that the insured actually breached any fiduciary duties, and the action results in a settlement or a judgment against the insured, it is possible that Zurich and Federal would be liable for funds spent to settle the suit or pay the judgment.”

Finally, the Court rejected IBM’s reliance on the fact that Federal subsequently revised its own policies to make more explicit the concept that coverage is limited to instances where insureds are acting in their capacities as fiduciaries.  The Court rejected IBM’s reliance on other language contained in subsequently issued policies, explaining:

It is simply not the case that because the challenged provision could have been worded differently, it is ambiguous and must be construed in IBM's favor. There are often many ways of effectively conveying the same meaning and the question is not simply whether the insurer could have phrased the provision differently. Rather, the issue is, in light of the reasonable expectations of the average policy holder, whether the provision, as written, is sufficiently clear and precise such that there is no room for reasonable disagreement about the scope of coverage.

The Court agreed that the Zurich policy was sufficiently clear and precise in its scope.  Thus, the Court of Appeals affirmed the decision of the Appellate Division, concluding that IBM was not entitled to coverage under Federal’s policy since the underlying suit did not allege a “wrongful act” as that term was defined by the Zurich policy.

Fifth Circuit Addresses Contractual Liability Exclusion

In its recent decision in Colony Nat'l Ins. Co. v. Manitex, L.L.C., 2012 U.S. App. LEXIS 3311 (5^th Cir. Feb. 20, 2012), the United States Court of Appeals for the Fifth Circuit, applying Texas law, considered what constituted an “insured contract” for the purpose of a contractual liability exclusion in a general liability policy.

Manitex involved two asset purchase agreements effecting a transfer of the assets and certain liabilities of an initial product manufacturer. JLG manufactured and sold a line of boom truck cranes.  Powerscreen purchased JLG’s assets and liabilities, including JLG’s liabilities associated with the cranes.  Powerscreen, in turn, was sold to Manitex, which assumed Powerscreen’s liabilities associated with the cranes.  Manitex was insured under a general liability policy issued by Colony.  During the Colony policy period, an individual was injured while using of the JLG manufactured cranes.  That individual later filed suit against JLG, and Manitex provided JLG with a defense in the suit.  Colony sought a judicial declaration that it did not have an obligation under its policy to indemnify Manitex for its own indemnity obligations vis-à-vis JLG.   The United States District Court for the Western District of Texas ruled on motion for summary judgment that Colony at least had a duty to reimburse Manitex for costs incurred in defending JLG.  On interlocutory appeal, however, the Fifth Circuit reversed the lower court.

The exclusion at issue in Manitex was a contractual liability exclusion barring coverage for “bodily injury” or “property damage” for which Manitex became obligated to pay “by the reason of the assumption of liability in a contract or agreement.”  The exclusion contained a typical exception for liability “assumed in an ‘insured contract,’” but only if the “bodily injury” or “property damage” occurred subsequent to the execution of the contract or agreement.  “Insured contract,” in turn, was defined as:

f.          That part of any other contract or agreement pertaining to your business (including indemnification of a municipality in connection with work performed for a municipality) under which you assume the tort liability of another party to pay for "bodily injury" or "property damage" to a third person or organization. Tort liability means a liability that would be imposed by law in the absence of any contract or agreement.

At issue for the court was whether Manitex’s purchase agreement constituted an “insured contract,” and more specifically, whether Manitex assumed JLG’s tort liability pursuant to the agreement it entered into with Powerscreen. 

Colony argued that the “insured contract” exception did not apply because the purchase agreements did not effect a transfer of JLG’s tort liabilities to Manitex.  The court summarized Colony’s argument as follows:

[Colony] contends that JLG is the only entity that has any "tort liability" as the policy defines that term because only JLG's liability would be imposed by law in the absence of any contract or agreement. Manitex's liability, argues Colony, can only be imposed by operation of the Powerscreen–Manitex Purchase Agreement. Therefore, that liability is not "tort liability," but contractual liability, and as a result, the Powerscreen–Manitex Purchase Agreement is not an insured contract, and Manitex's liability falls within the contractual liability exclusion and outside of coverage by the policy.   

The lower court rejected this very argument, concluding among other things, that Manitex assumed JLG’s tort liabilities, and that “"[a]n insurance policy that specifically covered contractually-assumed tort liability, yet removed from coverage any agreement involving more than a single contractual link, seems unlikely to have been intended by the parties.”

The Fifth Circuit, however, took a much more narrow view of the “insured contract” exception, concluding that Manitex did not contractually assume JLG’s tort liabilities, but instead assumed only the liabilities of Powerscreen.  The court found a significant distinction to be critical:

Powerscreen's liability arose strictly from a contract, namely, its purchase agreement with JLG. If that contract did not exist, then Powerscreen would have had no liability related to the [underlying] claims. Powerscreen's liability, therefore, was not one that “would be imposed by law in the absence of any contract or agreement.” Therefore, it was not “tort liability.”

Thus, the court concluded, because the Manitex agreement with Powerscreen did not effect a transfer of Powerscreen’s tort liabilities, it did not constitute an “insured contract,” and the contractually liability exclusion, therefore, barred coverage for Manitex’s costs in defending JLG.

Texas Court Considers Prior Knowledge Condition In D&O Policy

In the recent decision in Deer Oaks Office Park Owners Ass'n v. State Farm Lloyds, 2012 U.S. Dist. LEXIS 19240 (W.D. Tex. Feb. 15, 2012), the United States District Court for the Western District of Texas had occasion to consider a prior knowledge condition in a directors and officers liability policy.

The insured, Office Park, was “an office park condo association which owns, maintains and regulates the 'common areas' between fifteen unconnected office condos” in San Antonio, Texas.  In 2007, it sold one of the condominium units to a doctor who intended to convert the unit for use in his medical practice.  The doctor advised that being able to install an elevator into the unit was an important aspect and condition of his purchase.  After the sale, however, the doctor was unable to obtain a permission from building maintenance to install the elevator.  He subsequently complained to Office Park, and later commenced a lawsuit in Texas state court.

Office Park sought coverage for the suit under the directors and officers coverage of its policy with State Farm Lloyds, effective for claims first made during the period January 30, 2010 to January 30, 2011, which encompassed the period in which the doctor commenced suit.  The policy’s insuring agreement stated that coverage “applies to 'wrongful acts' committed before this optional coverage became effective if the insured had no knowledge of a claim or suit at the effective date of this option and there is no other applicable insurance.”  State Farm Lloyds denied coverage for the suit on the basis that Office Park had knowledge of the doctor’s claim prior to the policy’s inception.  Specifically, State Farm Lloyds relied on a September 23, 2009 letter from the doctor’s attorney that “traced [the doctor’s] multiple complaints about Office Park and attributed monetary losses to Office Park.”  

Office Park argued that the doctor’s letter did not constitute a “claim” or notice of a “claim,” because the letter did not specifically demand any monetary relief.  In support of its position, Office Park pointed out that the State Farm Lloyds policy did not contain a definition of the term “claim,” and that as such, under the Fifth Circuit decision in Int'l Ins. Co. v. RSR Corp., 426 F.3d 281 (5th Cir. 2005), the term “claim” must be narrowly construed as “a demand for money, property, or legal remedy.” Office Park contended that because the doctor’s September 23, 2009 letter did not actually seek monetary relief, it could not constitute a “claim” for the purpose of the policy’s “knowledge of a claim or suit” condition to coverage.

The court disagreed with Office Park’s restrictive reading of RSR Corp., finding that the term “claim” is not limited solely to demands for monetary relief, but instead encompasses any assertion of a legal right.  Such an interpretation, the court explained, ordinarily is favorable to the insured, rather than the insurer, “because the construction gives the insured the right to seek coverage without waiting for the filing of a lawsuit.”  The court went on to conclude that the doctor’s letter qualified as a “claim” because it clearly stated a legal demand for relief and advised of the potential for litigation should an accommodation not be made.  As the court explained:

The only reasonable interpretation of the letter is that [the doctor] asserted a right to hold Office Park liable for all of the costs [he] had spent and lost because of Office Park's acts. The letter's bottom line was: If you do not comply with my demands, I will sue you. Under any construction, the letter constituted a claim.

As such, the court concluded that State Farm Lloyd’s denial of coverage was correct and that it had no duty to defend or indemnify the doctor in connection with the underlying matter.

Massachusetts High Court Awards $22 Million In Bad Faith Damages

In its recent decision in Rhodes v. AIG Domestic Claims, et al., 2012 Mass. LEXIS 28 (Mass. Feb. 10, 2012), the Supreme Judicial Court of Massachusetts, Massachusetts’ highest court, addressed how damages are to be awarded under Massachusetts’ General Law 93A, § 9 (Massachusetts’ consumer protection statute) for an insurer’s failure to effectuate a prompt, fair and equitable settlement with a claimant, both prior to and following a verdict in an underlying lawsuit.

The underlying matter in Rhodes involved an accident between a tractor-trailer leased and operated by the insured, GAF, and a passenger vehicle, causing catastrophic injuries to plaintiff and rendering her a paraplegic.  GAF had $2 million in primary coverage through Zurich and $50 million in excess umbrella coverage through National Union.  AIG Domestic Claims (“AIGDC”) was the entity tasked with handling the claim on behalf of National Union.  Following an initial investigation, GAF’s third-party administrator advised Zurich and AIGDC in writing that liability was clear.  After suit was filed, the same third-party administrator estimated the value of the case to be between $5 million and $10 million.  A year later, after the driver of the truck plead guilty to a criminal charge relating to his operation of the vehicle, plaintiff made a settlement demand of $18.5 million, which was later reduced to $16.5 million.

Zurich tendered its $2 million limit to AIGDC.  Six months prior to trial, AIGDC attended a meeting with defense counsel at which time it was advised that the average settlement value for comparable cases was $6.6 million and the average jury verdict was $9.6 million.  Notwithstanding, just weeks later, an initial settlement offer was made to plaintiffs in the amount of $2 million, representing the value of the Zurich policy.  The Rhodes court noted that following this initial settlement offer, AIGDC engaged in delay tactics to avoid mediating the case until just one month prior to trial.  At the mediation, AIGDC offered $2.75 million, and later offered $3.5 million after plaintiffs countered at $15 million.  The court noted that the AIGDC representative attended the mediation with authority to settle up to $3.75 million, but elected not to make such an offer, even as the damages analysis changed for the worse at the mediation.  Instead, the AIGDC representative left the mediation one hour after making his offer of $3.5 million.  The matter ultimately went to trial, on damages alone (GAF had stipulated to liability), and the jury returned with a verdict, which when combined with interest, totaled $11.3 million. 

GAF immediately moved for a new trial and for an appeal.  Shortly thereafter, plaintiffs sent demand letters to Zurich and AIGDC pursuant to G.L. c. 93A, alleging that the insurers had failed to effect a prompt and equitable settlement.  This statute authorizes an individual to prosecute an action for unfair business practices, including violation of c. 176D, which is Massachusetts’ unfair insurance practices statute.  C. 176D, § 3(9)(f) defines unfair claim settlement practices to include “[f]ailing to effectuate prompt, fair and equitable settlements of claims in which liability has become reasonably clear.”  AIGDC responded to plaintiffs’ demand letter one month later by offering to settle both the underlying matter and the c. 93A claim for $7 million, which included Zurich’s $2 million.  Zurich separately responded to the plaintiffs by paying an amount just in excess of $2 million.  Plaintiffs and AIGDC thereafter settled the underlying negligence claim for $8.965 million, but with plaintiffs maintaining their right to prosecute their c. 93A claim. 

In a subsequent bench trial on the issue, a Massachusetts trial court found that AIGDC willfully and knowingly breached its duty to make a fair and reasonable offer prior to trial once liability and damages became reasonably clear, but that the evidence established that plaintiffs would not have accepted any such offer, and as such, damages were not available under c. 93A for AIGDC’s preverdict conduct.  The court went on, however, to find that AIGDC engaged in postverdict misconduct by failing to effectuate a prompt and fair settlement after the verdict was returned.  The court specifically found that AIGDC’s offer of $7 million was “not only unreasonable, but insulting.”  The judge awarded plaintiffs loss of use damages for this violation in the amount of $448,250, calculated as the lost interest on the $8.965 million settlement from the date the matter should have settled to the date that it actually did settle.

The case was appealed to the Massachusetts Appeals Court, which held that plaintiffs should have been awarded damages for AIGDC’s preverdict conduct.  On further appellate review, the Massachusetts Supreme Judicial Court (“SJC”) agreed that plaintiffs established a violation of c. 93A with respect to AIGDC’s pretrial conduct by showing that they suffered a loss due to AIGDC’s failure to make a timely, reasonable offer.  Moreover, the SJC held that the lower court erred in considering whether plaintiffs would have accepted such an offer, since such is not a relevant consideration in finding a violation of the statute.  Notwithstanding, the SJC held that it was not necessary to determine plaintiffs’ damages as a result of AIGDC’s pretrial conduct, since plaintiffs could not recover twice for AIGDC’s failure to effectuate a prompt and reasonable settlement.  As such, the SJC focused solely on what damages were available to plaintiffs as a result of AIGDC’s postverdict conduct.

Toward this end, the SJC looked to the language of c. 93A § 9(3), which states that in the event of a violation, the “recovery shall be in the amount of actual damages or twenty-five dollars, whichever is greater; up to three but not less than two time such amount if the court finds that the use of employment of the act or practice was a willful or knowing violation … .”  This language, reasoned the SJC, dictated that the damages available to plaintiffs were the actual value of the verdict, multiplied by no less than two since the lower court concluded that AIGDC’s conduct was willful and knowing.  In other words, the lower court’s “loss of use” analysis, which awarded damages based on lost interest, was not an appropriate methodology for calculating c. 93A damages.  Instead, the SJC concluded that plaintiffs should have been awarded $22 million, representing the underlying $11 million verdict multiplied by two.

In reaching its holding, the SJC rejected AIGDC’s arguments that damages under c. 93A should not be awarded since plaintiffs’ underlying tort injuries did not arise out of AIGDC’s claims handling conduct.  In particular, the SJC rejected AIGDC’s arguments that the statute only applies in the first-party insurance context, or that the judgment against GAF did not arise out of the same transaction or occurrence as the c. 93A claim.  The latter argument, explained the SJC, was a matter of form over substance and not relevant to recovery under the statute.  The SJC further rejected AIGDC’s contention that the multiplied damages aspect of c. 93A was “grossly excessive” and thus violative of the Fourteenth Amendment.  Such an argument, explained the court, ignored the fact that AIGDC’s conduct in failing to effect a prompt settlement despite the clear evidence of liability and damages was “sufficiently reprehensible” and that in any event, the ratio between compensatory damages and punitive damages was not excessive.  The SJC, in passing, acknowledged that “$22 million in c. 93A damages is an enormous sum,” but that “the language and history of … c. 93A leave no option but to calculate the double damages award against AIGDC based on the amount of the underlying tort judgment.”

Texas Court Considers Prior Acts Condition in Professional Liability Policy

In its recent decision in Darwin Select Ins. Co. v. Laminack, 2012 U.S. Dist. LEXIS 15712 (S.D. Tex. Feb. 8, 2012), the United States District Court for the Southern District of Texas had occasion to consider the scope of a prior acts condition in a lawyers’ professional liability policy. 

The insured law firm of Laminack, Pirtle & Martines, L.L.P., and in particular two individual attorneys of the firm, were named as defendants in an underlying legal malpractice action filed in October 2010 arising out of the attorneys’ representation of the plaintiff in an antitrust lawsuit years earlier.  Plaintiff claimed that the attorneys advised him on several occasions that he was not in danger of missing the statute of limitations to file his antitrust lawsuit.  This, however, proved not to be the case.  In 2008, a Texas federal district court dismissed the antitrust action based on the statute of limitations having expired prior to the time suit was filed.  This holding was affirmed by the Fifth Circuit Court of Appeals in 2009. 

The claims made errors and omissions policy at issue incepted in June 2010, some four months prior to the filing of the malpractice action.  The policy stated that coverage was unavailable for any “‘wrongful act’ occurring before the inception date of the Policy if, prior to the inception date, any Insured had a basis to foresee that the Wrongful Act might reasonably be expected to be the basis of a Claim against any Insured.”  The insurer, Darwin, denied coverage to its insureds on the basis that prior to the policy’s June 2010 inception date, the insureds had a reasonable basis to expect that they would be sued as a result of their alleged malpractice.

The court determined, as an initial matter, that there was no question that the insureds were aware of the unfavorable statute of limitations rulings concerning their representation of plaintiff.  The court further determined that applying an objective standard, as required by the language of the prior acts condition (i.e., “reasonably be expected”), as a matter of law, the insureds knew or should have known that they would the subject of a malpractice claim.   As the court explained, “it is inconceivable that two experienced, accomplished attorneys, having received notice that a federal district judge had determined that they filed a lawsuit outside the statute of limitations, would not have a basis to foresee that missing the filing deadline might reasonably be expected to be the subject of a malpractice claim against them.”  As such, the court held as a matter of law that the insureds did not satisfy the policy’s prior acts condition, and as a consequence, the insurer had no duty to defend or indemnify.

4th Circuit Applies Pro Rata Allocation

In its recent decision in Pennsylvania National Mutual Cas. Ins. Co. v. Roberts, 2012 U.S. App. LEXIS 2084 (4^th Cir. Feb. 3, 2012), the United States Court of Appeals for the Fourth Circuit, applying Maryland law, had occasion to consider allocation of loss arising out of a lead paint bodily injury lawsuit.

Plaintiff in the underlying matter was diagnosed with elevated blood lead levels in September 1992, when she was twenty (20) months old.  She continued to exhibit elevated blood levels through August 1995.  Plaintiff’s suit named as a defendant Attsgood, which owned and managed the property where plaintiff lived from the time of her birth through November 1, 1993.  Plaintiff’s complaint also named as a defendant the subsequent property owner, who defaulted.  Attsgood was insured through Penn National under consecutive general liability policies covering the period January 13, 1992 (subsequent to plaintiff’s birth) through January 13, 1994. The underlying suit eventually resulted in an award to plaintiff in the amount of $850,000, and a finding that Attsgood and the subsequent property manager were jointly and severally liable for the amount.

Following the verdict, Penn National sought a declaratory judgment against Attsgood and the plaintiff, arguing that it was responsible only for 22 months of the entire period in which plaintiff was exposed to lead, that period being from January 13, 1992 through November 1993 when Attsgood sold the property. While Attsgood defaulted in the declaratory judgment action, plaintiff contested Penn National’s allocation theory, arguing that in light of the joint and several finding as to both defendants, Penn National should be responsible for paying the entirety of the $850,000 award. The Maryland federal district court rejected plaintiff’s argument.  Instead, applying a continuous trigger theory, the lower court held Penn National was responsible for 24 months (i.e., the full two years of the policies) of the 55 months that plaintiff was exposed to lead conditions (from her January 1991 birth through August 1995 when her blood lead levels normalized). Thus, the court concluded, Penn National was responsible for 24/55 of the underlying award, or $370,600.

On appeal, the Fourth Circuit affirmed the lower court’s ruling that Penn National should not be responsible for paying the entirety of the underlying judgment.  Any other outcome, noted the court, would be contrary to the plain language of Penn National’s policies, which applied to “bodily injury” happening during the respective policy periods.  As the court explained, “the contract does not cover damages Attsgood became legally obligated to pay for injuries that occurred outside of the policy period.”  (Emphasis supplied.)  Moreover, plaintiff’s argument ran contrary to well-established Maryland law applying a pro rata by time on the risk allocation of liability in lead paint liability matters.  Plaintiff argued that these cases should not apply because they did not involve multi-defendant cases. The Fourth Circuit found this distinction “entirely unpersuasive,” concluding that the pro rata methodology stems from the language of the insurance policy, not from the number of defendants involved.  Finally, the court found that as a matter of public policy, it would simply be unfair to saddle Penn National with losses that happened outside the periods of its policies.

While the court agreed that pro rata allocation was proper, it nevertheless concluded that the lower court erred in determining Penn National’s allocated share of the loss.  The court agreed that the trigger period was 55 months, running from plaintiff’s date of birth through the date that her blood lead levels normalized.  The Fourth Circuit held, however, that the proper numerator was not 24 months, but instead 22 months, representing the period of time in which the Attsgood owned the property at which plaintiff resided.  Thus, the court found Penn National responsible for 22/55 of the underlying loss rather than 24/55.

New York Court Addresses Impact of Allowing Insured to Default

In its recent decision in Sunnyside Dev. Co., LLC v. Chartis Specialty Ins. Co., 2012 U.S. Dist. LEXIS 9392 (S.D.N.Y. Jan. 26, 2012), the United States District Court for the Southern District of New York demonstrated the consequences that an insurer faces when allowing an insured to default.

Chartis insured Opsys under a pollution legal liability policy that provided first and third party liability coverage for a property that Opsys leased from Sunnyside in Fremont, California.  Opsys used the premises for research and development in the organic light emitting diode industry.  During the policy term, Opsys filed for Chapter 7 bankruptcy, which triggered a regulatory inspection of Opsys’ facility, which in turn resulted in a Notice of Violation based on “a condition dangerous to human health, property, and the environment by abandoning hazardous materials and hazardous waste.”  As a result, Sunnyside was advised that the property could not be re-occupied until a Closure Order was issued.

Chartis paid certain costs under the policy relating to pollution caused as a result of leaking or ruptured drums within the facility.  Sunnyside nevertheless received permission from the bankruptcy court to commence suit against Opsys, to obtain benefits under the Chartis policy, primarily relating to lost rent resulting from its inability to lease the facility while undergoing remediation.  Sunnyside thereafter commenced suit against Opsys in California, and advised Chartis that it intended to take a default against Opsys if the action was not defended.  For reasons not clear, Chartis did not provide a defense, and Sunnyside eventually obtained a default judgment against Opsys for the $1 million limit of the Chartis policy.

After determining that Chartis received proper notice of the pending default, and had an opportunity to defend the suit, and even had an opportunity to attempt to vacate the default after it had been entered, the court considered the effect of Chartis’ inaction.  Chartis argued that Sunnyside failed to demonstrate that its damages were caused as a result of a “pollution condition,” a term defined in pertinent part as a “leak” or a “release,” but instead were caused as a result of an abandonment or the mere presence of pollutants.   While court agreed that Chartis could raise defenses to its policy’s coverage, since coverage was not technically at issue in Sunnyside’s suit against Opsys, the court nevertheless held that Chartis could not relitigate facts that were decided in Sunnyside’s suit against Opsys.  Thus, the California court’s judgment that there was property damage at the premises resulting from leaking or ruptured drums, and that there was a release of hazardous materials, even if inaccurate, was nevertheless binding on Chartis for the purpose of determining coverage.  As the court explained, “if Chartis wanted to litigate the proximate cause of Sunnyside's damages, it should have intervened in the California Action or moved to set aside the Default Judgment.”