New York Court Addresses Business Enterprise Exclusions

In its recent decision in Admiral Ins. Co. v. Adges, 2012 U.S. Dist. LEXIS 89355 (S.D.N.Y. June 27, 2012), the United States District for the Southern District of New York had occasion to consider whether a business enterprise exclusion in a legal malpractice policy applied to bar coverage for an underlying lawsuit.

Admiral Insurance Company insured Michael Adges under a lawyers’ professional liability policy.  Adges sought coverage under the policy for an underlying lawsuit naming him as a defendant individually and under his trade name Silver Lining Realty.  The lawsuit alleged several causes of action, including conversion, misappropriation, fraud, and deceptive trade practices, relating solely to Silver Lining Realty’s business.

Admiral’s policy contained two relevant exclusions.  The first barred coverage for any claim:

E.   based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving any Insured’s activities or their capacity as:

1.   an officer, director, partner, trustee, or employee of a business enterprise, not named in Item 1 of the Declarations …

This exclusion E. applies whether or not the Insured’s activities or capacity also constitute or involve Professional Services.

The second relevant exclusion applied to claims:

F.   by or in connection with any pre or post formation business enterprise, not named in Item 1. of the Declarations, in which any Insured owns or owned, or controls or controlled, more than a 10 percent interest, or in which any Insured is or was an owner, partner, or employee, or which is directly or indirectly controlled, operated, or managed by an Insured …

This exclusion F. applies whether or not the Insured’s activities also constitute or involve Professional Services.

The court observed that courts in New York, as well as other jurisdictions such as Pennsylvania, Louisiana, Ohio and Arizona routinely enforce business enterprise exclusions.  The relevant consideration is whether the insured is being sued in connection with a business enterprise other than the entity specifically insured under the policy.  Finding that the underlying suit related solely to Silver Lining Realty, and not the insured law practice, the court concluded that both policy exclusions applied to bar coverage.  

Oregon Federal Court Holds No Duty to Pay Insured’s Appellate Costs

In its recent decision in City of Medford v. Argonaut Ins. Group, 2012 U.S. Dist. LEXIS 86114 (D. Ore. June 21, 2012), the United States District Court for the District of Oregon had occasion to consider whether an insurer’s duty to defend includes an obligation to pay for appellate costs involving non-covered claims.

The insured, City of Medford, was named as a defendant in two underlying suits brought by retired and current employees, all of whom alleged that the City failed to provide health care insurance to retired employees.  In the first suit, brought by four retired employees, the City was sued for age discrimination, statutory violations and breach of contract.  The second suit, brought by current employees, alleged similar causes of action and also sought injunctive relief.  The City’s employment practices liability insurer, Northland Insurance Company, provided the City with a defense in both suits.  Both suits resulted in partial verdicts in favor of the plaintiffs, although for relief not covered under the Northland policy.  The suit brought by the former employees resulted in an award only for breach of contract.  The suit brought by the current employees resulted only in an award of injunctive relief, requiring the City to purchase health care insurance that would continue after an employee’s retirement.

Northland contended that it had no duty to indemnify the City for the verdicts in both matters, and the court agreed, observing that the Northland policy had specific exclusions with respect to breach of contract damages and injunctive relief.  The more complicated issue for the court was whether Northland had a duty to defend the City in connection with its own appeal of the two underlying suits.  The court acknowledged that there was little case law guidance on the issue from Oregon courts, although at least one Oregon court had concluded that the duty to defend can include the duty to defend an appeal.  Goddard ex rel. Estate of Goddard v. Farmers Ins. Co., 22 P.3d 1224  (Ore. App. 2004).  The court noted, however, that as a general proposition, when a complaint is amended and the only potentially covered causes of action are no longer included in the amended pleading, then the duty to defend is terminated.  National Union Fire Ins. Co. v. Starplex Corp., 188 P.3d 332 (Ore. App. 2008).  The court further cited to a case from a Utah federal district court holding that “when a judgment eliminates all covered claims against the insured, and the dismissal of the covered claims is not appealed, the insurer no longer has a duty to defend.” Crist v. Insurance Co. of North America, 529 F. Supp. 601 (D. Utah 1982).

From these lines of cases, the Oregon court concluded that in the absence of covered or even potentially covered claims, the duty to defend is necessarily eliminated.  Because the only successful counts against the City – for breach of contract and injunctive relief – fell outside of the policy’s coverage, Northland could have no continuing obligation to defend the City in connection with further litigation on those particular counts.  As such, and because plaintiffs did not cross-appeal with respect to any of the potentially covered claims on which they were unsuccessful, the court concluded that Northland had no duty to pay the City’s costs associated with the appeals.  Notably, the court did not take into consideration which party initiated the appeal, but rather only the substance of the issues on appeal.

Michigan Court Holds No Duty to Defend Computer Hacking Claim

In its recent decision in Coral Reef Prods. v. AXIS Surplus Ins. Co., 2012 Mich. App. LEXIS 1149 (Mich. App. June 19, 2012), the Michigan Court of Appeals had occasion to consider whether a claim for computer hacking fell within a professional liability policy’s exclusion applicable to ill-gotten gains.

Coral Reef Products was insured under a miscellaneous errors and omissions policy issued by AXIS.  Coral Reef was sued by the company Primesites for allegedly hacking into Primesites’ customer lists and soliciting Primesites’ customers. Coral Reef was alleged to have falsely informed these customers that it was affiliated with Primesites.  AXIS’ policy insured Coral Reef for “Insured Services,” defined, in pertinent part, as “[t]alent consulting including talent promotion and membership services for others.”  The court agreed with Coral Reef that the phrase “membership services” was ambiguous, and as such, the conduct alleged by Primesites potentially fell within the policy’s insuring agreement.

The court nevertheless concluded that coverage was negated by the following exclusions:

A.        The Company is not obligated to pay Damages or Claim Expenses or defend Claims for or arising directly or indirectly out of:

                                                               * * *

2. An act or omission that a jury, court or arbitrator finds dishonest, fraudulent, criminal, malicious or was committed while knowing it was wrongful. This exclusion does not apply to any Individual Insured that did not commit, acquiesce or participate in the actions that gave rise to the Claim.

                                                             * * *

  4. Unfair competition, restraint of trade or any other violation of antitrust laws.

                                                             * * *

  6. Gain, profit or advantage to which any Insured is not legally entitled.

The court held that these exclusions, in particular A.4 and A.6 applied to allegations of computer hacking and retrieving and misusing Primesites’ proprietary customer database.  The court explained that “[a]t a minimum, Primesites’ claims arose directly or indirectly out of the advantage Coral Reef gained as a competitor of Primesites when, allegedly, it unlawfully obtained access to Primesites’ Customer Lists and subsequently contacted Primesites’ customers.”

6th Circuit Addresses Prior Knowledge Defense Under Legal Malpractice Policy

In its recent decision in Schwartz Manes Ruby & Slovin, L.P.A. v. Monitor Liability Managers, LLC, 2012 U.S. App. LEXIS 12236 (6th Cir. June 15, 2012), the United States Court of Appeals for the Sixth Circuit, applying Ohio law, had occasion to consider the issue of whether prior to the inception of a policy, the insured reasonably could have foreseen that a claim would be made.

Schwartz Manes involved coverage for alleged legal malpractice under a professional liability policy.  The Schwartz Manes law firm (“SMRS”) represented an individual in connection with a property dispute.  After having failed to appear at a scheduled trial in 2005, judgment was entered against SMRS’ client.  The client later retained a second firm, which after reviewing SMRS’ file, wrote SMRS by letter dated June 15, 2008 to inquire as to why the firm failed to appear at the trial, particularly since its file contained a notice for the trial.  On July 10, 2008, after undertaking an internal investigation, SMRS advised its insurance agent of a potential claim, but the agent apparently never forwarded this information to anyone else.  On July 24, 2008, Carolina Casualty Insurance Company issued to SMRS a legal malpractice policy for the period June 29, 2008 to June 29, 2009. SMRS was later sued for malpractice in January 2009.

The Carolina policy contained the following insuring agreement:

This Policy shall pay on behalf of the Insured all Damages and Claims Expense that the Insured shall become legally obligated to pay, arising from any Claim first made against an Insured during the Policy Period and reported to the Insurer in writing during the Policy Period or within 60 days thereafter, for any Wrongful Act, provided that prior to the inception date of the first Lawyers' Professional Liability Insurance Policy issued by the Insurer to the Named Insured, which has been continuously renewed and maintained in effect to the inception of this Policy Period, the Insured did not know, or could not reasonably foresee that such Wrongful Act might reasonably be expected to be the basis of a Claim.  (Emphasis supplied.)

Carolina disclaimed coverage to SMRS on the basis that prior to its policy’s June 29, 2008 date of inception, SMRS knew and reasonably could have foreseen that a claim would be made relating to its alleged malpractice.  On motion for summary judgment, the United States District Court for the Southern District of Ohio agreed, holding that SMRS’ knowledge of the potential claim prior to the issuance of the Carolina policy negated Carolina’s duty to defend or indemnify.

On appeal, the Sixth Circuit observed that the question of whether SMRS could reasonably foresee that a Wrongful Act “might reasonably be expected” to be the basis of a claim required both a subjective and an objective analysis.  The subjective part of the analysis inquired into what facts SMRS knew of prior to the policy’s date of inception.  The objective analysis, on the other hand, inquired into whether a “reasonable insured” in possession of similar facts, would have expected a claim.

SMRS argued that the phrase “reasonably be expected” was necessarily ambiguous, and that it was not clear whether the claim only be a possibility, or whether the phrase should be interpreted more narrowly to claims that are “probable.”  The court concluded that it need not determine whether the phrase is ambiguous, “because even under a more favorable interpretation, a reasonable insured would have expected a malpractice claim …  against SMRS to be reasonably probable.”  It was the court’s opinion that a reasonable insured having knowledge of the underlying judgment resulting from SMRS’ failure to appear at the trial, would have realized that a claim was “reasonably probable.”

As a secondary argument, SMRS argued that only that aspect of the malpractice claim relating to its failure to appear at the trial should be precluded.  SMRS argued that other aspects of underlying plaintiff’s claim, such as failure to assert certain defenses, should not be precluded from coverage SMRS could not have predicted such aspects of the suit prior to the date of the policy’s inception.  The court rejected this argument, finding that there was no way to meaningfully divorce SMRS’ failure to attend the trial from other aspects of the alleged malpractice.  The court further held that the policy’s “related wrongful act” language precluded such a parsing of claims, observing:

… Section IV(K) of the Policy also excludes coverage for "Related Wrongful Acts." The Policy defines "Related Wrongful Acts" as "Wrongful Acts which are logically or causally connected by reason of any common fact, circumstance, situation, transaction, casualty, event or decision." SMRS's alleged failure to comprehensively research and litigate Kissel's lawsuit and potential countersuit against her step-mother is certainly logically connected to its alleged failure to attend her trial in the same matter.

Thus, the Sixth Circuit upheld the lower court’s grant of summary judgment in Carolina’s favor.

Texas Court Considers Notice Prejudice Rule for Time Element Pollution Exclusion

In its recent decision in St. Paul Surplus Lines Ins. Co. v. Davis Gulf Coast, Inc., 2012 U.S. Dist. LEXIS 81719 (S.D. Tex. June 13, 2012), the United States District Court for the Southern District of Texas had occasion to consider the enforceability of a provision requirement reporting of a pollution condition within ninety (90) days.

The insured, Davis Gulf Coast, operated an oil and gas lease on Matagorda Island in Texas.  Davis’ general liability policy, issued by St. Paul, had a pollution exclusion with a sudden and accidental cleanup cost exception, thus granting coverage for cleanup costs associated with a “sudden and accidental pollution incident,” defined by the policy as:

Sudden and accidental pollution incident means the discharge, dispersal, escape, or release of a pollutant that:

•     is sudden and accidental;

•     begins on a specific date and at a specific time while this agreement is in effect;

•     is first known within 30 days of its beginning by you or any of your employees, your operating agent or any of its employees, or your pumper-gauger or any of its employees;

•     any protected person, your operating agent, or your pumper-gauger attempts to end as soon as possible after it first becomes known by you or any of your employees, your operating agent or any of its employees, or your pumper-gauger or any of its employees; and

·      is reported to us within 90 days after it first becomes known to you or any of your employees, your operating agent or any of its employees, or your pumper-gauger or any of its employees.  (Emphasis supplied.)

Thus, by its express terms, “sudden and accident pollution incident” is defined as a discharge, dispersal, release, etc. that becomes known to the the insured within thirty (30) days of its commencement and that it is reported to St. Paul within ninety (90) days of such knowledge.  At issue before the court was Davis’ reporting of a pollution incident some two hundred days after it learned of the incident.  Davis and St. Paul agreed that this delay was a breach of the ninety-day reporting requirement.  Davis nevertheless argued that its non-compliance should be excused absent prejudice to St. Paul.

Applying Oklahoma law, the court agreed that the timing elements of the definition of “sudden and accidental pollution incident” (both as to learning of the release and reporting same) were not generic notice requirements, but instead were “an integral part of the definition of the risk covered.”  The court contrasted this with the notice provision applicable to the remaining coverages under the policy (i.e., bodily injury, property damage, and personal and advertising injury), which required only notice “as soon as possible.”  The court therefore concluded that there was an internally consistency within the policy of treating the cleanup cost coverage differently than the other risks covered under the policy, and that it would be improper to rewrite the policy so as to ignore the ninety (90) day reporting requirement. 

More significantly, the court rejected Davis’ argument that the Oklahoma body of case law concerning the notice-prejudice rule should be applied.  The court observed the ninety-day reporting requirement for cleanup cost coverage to be more akin to claims made coverage rather than occurrence-based coverage, and as such, case law concerning the latter were not relevant.  Moreover, the court found the ninety-day reporting requirement consistent with the risk offered and the premium charged, explaining:

It is common knowledge that oil and gas pollution clean-up costs can be enormous, and any comprehensive general liability occurrence policy with open-ended liability for that risk would undoubtedly carry with it a commensurately enormous premium. The bargain struck here by Davis and St. Paul is quite different. Davis acquired insurance only for pollution clean-up costs arising from a release of a pollutant that is "sudden and accidental," beginning on a specific date and time, which becomes known to the insured within 30 days of the release and is reported by the insured to St. Paul within 90 days after the insured learns of it. Thus, St. Paul by definition effectively assumed a rolling window of exposure for a maximum of 120 days after the date of any sudden and accidental pollution incident. Concomitantly the premium for such limited and narrowly-defined pollution clean-up costs, in the words of Judge Cauthron of the Western District of Oklahoma, would be "much more reasonable and thus affordable." Id. In sum, the 90 days reporting requirement at issue here is not a general notice provision that requires the insurer to show prejudice if the insured does not comply, but rather, in language approved by Oklahoma caselaw, is "a definition of coverage."

In reaching its decision, the cited favorably to other cases from the Fifth Circuit that declined to apply a prejudice requirement where the insured failed to comply with a strict reporting requirement.  See, e.g., Matador Petroleum Corp. v. St. Paul Surplus Lines Ins. Co., 174 F.3d 653 (5th Cir. 1999) (agreeing that insured’s eight day delay in reporting pollution incident negated coverage regardless of prejudice); Certain Underwriters at Lloyd's London v. C.A. Turner Constr. Co., 112 F.3d 184, 189 (5th Cir. 1997).

New York’s Highest Court Addresses Rescission of Policy to Additional Insured

In its recent decision in Admiral Ins. Co. v Joy Contractors, Inc., 2012 NY Slip Op 4670 (N.Y. June 12, 2012), the New York Court of Appeals, New York’s highest court, considered whether a general liability policy can be rescinded to the detriment of an innocent additional insured.

Admiral Insurance involved coverage for liabilities associated with the collapse of a tower crane in Manhattan in March 2008.  The collapse resulted in numerous deaths and injuries, and caused significant property damage as well as the destruction of an entire building.  The policy’s named insured, Joy Contractors, had been operating the crane at the time of the collapse.  It was insured under a primary general liability policy issued by Lincoln, and a $9 million follow-form excess liability policy issued by Admiral.  Immediately following the incident, Joy gave notice to both Lincoln and to Admiral.  Several entities, including the project’s general contractor and the building’s owner, qualified as additional insureds under Joy’s policies.

Admiral initially issued a reservation of rights with respect to several grounds.  Included among these grounds was the right to rescind its policy on the basis that Joy had represented in its application that it specialized in drywall installation, that it did not perform building exterior work.  Admiral later denied coverage to Joy, and the additional insureds, on the basis of a residential construction exclusion in its policy.  It also took action to rescind the policy on the basis of the misrepresentation.  

As it related to rescission, the intermediate appellate court held that a policy could not be rescinded to the detriment of innocent additional insureds.  The appellate court relied primarily on the decisions in Lufthansa Cargo, AG v New York Mar. & Gen. Ins. Co., 834 N.Y.S.2d 659 (1st Dep’t 2007) and BMW Fin. Servs. v Hassan, 710 N.Y.S.2d 607 (2nd Dep’t 2000), lv denied 717 N.Y.S.2d 547 (2000), both of which addressed rescission to the detriment of an additional insured.  In BMW, the named insureds under an auto liability policy represented that they would be the primary drivers of a vehicle and that their children would be additional drivers, when in fact, the children were the primary drivers.  The court held that this misrepresentation should not operate to the detriment of BMW, named as an additional insured under the policy.  Likewise, in Lufthansa, the named insured represented that a certain employee would not be operating an insured truck, but it was that very same excluded driver that was operating the insured truck at the time of an accident.  The court held that Lufthansa, as an innocent additional insured, should not be affected by the named insured’s misrepresentation.

The New York Court of Appeals found BMW and Lufthansa distinguishable from the facts before it.  In both instances, the misrepresentations did not go to the fundamental nature of the risk being insured.  More specifically, the misrepresentations in those cases did not “deprive the insurer of knowledge of or the opportunity to evaluate the risks for which it was later asked to provide coverage — i.e., the risk of damages arising from automobile theft (BMW) and accident (Lufthansa).” Such misrepresentations were materially different than the named insured misrepresenting the entire nature of the risk to be insured, i.e., drywall installation as opposed to exterior building work employing the use of tower cranes.  As the court observed, “Admiral evaluated the risk of, and collected a premium for, providing excess insurance for interior drywall installation, not the obviously much greater risk presented by exterior construction work with a tower crane at a height many stories above grade.” 

Ultimately, the Court of Appeals held that the innocent “additional insured” decisions in BMW and Lufthansa, and the decisions on which those two cases were based, cannot have the effect of allowing coverage for an additional insured on a policy that is deemed never to have existed as a result of rescission.

Pennsylvania Court Considers Coverage for Gerry Sandusky Under D&O Policy

In its recent decision in Federal Ins. Co. v. Sandusky, 2012 U.S. Dist. LEXIS 76880 (M.D. Pa. June 4, 2012), the United States District Court for the Middle District of Pennsylvania had occasion to consider whether a D&O insurer was required to defend an employee of the insured in connection with underlying criminal and civil matters arising out of alleged molestation of children.

Federal Insurance Company issued a directors and officers and employment practices policy to The Second Mile, a charitable organization founded in part by Gerry Sandusky, who has received great notoriety for having allegedly molested numerous children both during and after his time as a coach for the Penn State football team.  Following a grand jury investigation, Sandusky was charged with forty criminal counts, including sexual assault and unlawful contact with a minor.  Sandusky and The Second Mile were also named as defendants in a civil suit filed in Pennsylvania.  Sandusky sought coverage under the Federal policy, and Federal advanced Sandusky’s criminal attorney $125,000 in legal fees, subject to a reservation of rights.  Federal thereafter filed a declaratory judgment action.

Federal agreed that Sandusky qualified as an insured person under the policy.  It nevertheless sought a declaration that Sandusky was not entitled to coverage for the underlying criminal and civil matters because he was not acting in an insured capacity as an employee or executive of The Second Mile when he committed the alleged acts.  Federal also contended that the policy’s D&O coverage excluded bodily injury, willful statutory violations and sexual harassment.  Prior to commencing discovery, however, Federal moved for judgment on the pleadings, arguing that “were The Second Mile’s insurance policy ultimately interpreted to cover losses stemming from the allegations of sexual abuse and molestation of minors, the insurance policy would be void as against Pennsylvania’s public policy.”  Thus, before addressing the coverage issues stemming from the policy, Federal sought a judgment based solely on public policy grounds.

The court acknowledged that “[s]exual abuse and molestation of children are ‘so obviously … against the public health, safety, morals or welfare that there is a virtual unanimity of opinion with regard to it.”  This unanimity of opinion, explained the court, is reflected in numerous Pennsylvania laws concerning the safety of children.  The court further observed that “public policy bars enforcement of insurance contracts that indemnify insured persons for damages arising from reprehensible conduct.”  Given these factors, the court determined that Pennsylvania would deem unenforceable, as a matter of law, any contract indemnifying the perpetrator of intentional sexual molestation of children.  As the court explained:

Such a contract would allow an insured to shift the consequences of intentional, reprehensible conduct to an insurance company, thereby abdicating personal responsibility. It is entirely clear, and this Court holds, that the public policy of Pennsylvania as announced by its courts prohibits the reimbursement of Sandusky for any damage award that he may ultimately be found to owe arising from the allegations that he molested and sexually abused children.

While the court concluded that Sandusky was not entitled to indemnification for the alleged conduct, it nevertheless struggled with the issue of whether he was entitled to a defense.  The court noted that the issue of whether providing a defense in a sexual molestation case violates public policy was one of first impression under Pennsylvania law.  The court acknowledged that general rule that there can be no duty to defend allegations that are not potentially covered, but explained that “where, as here, an insurance policy specifically includes defense costs as covered loss, separate and apart from damages, the mechanical process of determining whether there could be coverage for damages in order to determine whether there is a duty to defend cannot be applied.”

Ultimately, the court avoided ruling on the issue of defense costs, explaining that “[w]ithout the benefit of a factual record, it is not entirely clear that Pennsylvania's public policy would prohibit enforcement of the insurance policy to the extent that it provides Sandusky with defense costs.”  The court specifically concluded that further development of facts through discovery could bear on the issue of the court’s public policy determination, such as whether Sandusky himself purchased the Federal policy and did so knowing that criminal charges were imminent.