Sixth Circuit Holds Faulty Workmanship Is Not An Occurrence

In its recent decision in Liberty Mutual Fire Ins. Co. v. Kay & Kay Contracting LLC, 2013 U.S. Dist. LEXIS 23587 (6th Cir. Nov. 19, 2013), the United States Court of Appeals for the Sixth Circuit, applying Kentucky law, had occasion to consider whether a subcontractor’s allegedly faulty preparation of a building pad, and the resulting settling and structural damages to the building constructed on the building pad, constitutes an “occurrence.”

Liberty Mutual issued a CGL insurance policy to Kay & Kay as the named insured and included MW Builders as an additional insured (“the contractors”). Wal-Mart contracted with MW Builders as a general contractor to build a new Wal-Mart store. MW Builders in turn subcontracted with Kay & Kay to perform site preparation work and construct the building pad for the new store. After Kay & Kay completed the building pad and constructed the building, Wal-Mart notified MW Builders that there were cracks in the building’s wall. Wal-Mart demanded that MW Builders remedy these issues and fix the resulting damage. MW Builders in turn demanded that Kay & Kay remedy these issues and indemnify MW Builders from Wal-Mart’s claim. MW Builders and Kay & Kay reached an agreement and executed a new and separate contract under which Kay & Kay agreed to perform the remedial work demanded by Wal-Mart. Meanwhile, Liberty Mutual filed a complaint seeking a declaratory judgment against the contractors alleging that their claims were not covered under the CGL policy, in relevant part, because there was no “occurrence” alleged.

The CGL policy at issue contained the standard coverage language found in a standard Insurance Services Office form.  The policy provided: “This insurance applies to ‘bodily injury’ and ‘property damage’ only if…[t]he ‘bodily injury’ or property damage’ is caused by an ‘occurrence’ that takes place in the ‘coverage territory’… .” The policy defined “occurrence” to mean “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” The policy did not define the term “accident.”

The parties filed cross-motions for summary judgment on the limited issue of whether there was an “occurrence” alleged in the claim. After a hearing, the district court denied Liberty Mutual’s motion for summary judgment and granted the contractors’ motion. Liberty Mutual appealed.

Relying on Cincinnati Ins. Co. v. Motorists Mut. Ins. Co., 306 S.W. 3d 69, 73 (Ky. 2010), the court noted that, standing alone, claims of faulty workmanship are not “occurrences” under CGL policies. The contractors argued that the damage was not Kay & Kay’s allegedly defective building pad (the work product itself), but was instead the collateral damage to the building (other property), which was the work of third-party contractors. The Court recognized that in order for there to have been an “occurrence”, there had to have been an “accident.” Following Cincinnati, the court concluded that the plain meaning of the term accident implicated the doctrine of fortuity, and it recognized that fortuity consists of intent and control.

After a careful examination of Cincinnati, the Court held that the facts of the case did not present an “accident” that would trigger coverage as an “occurrence” under the CGL policy issued by Liberty Mutual. The Court emphasized the importance the Cincinnati court put on “control” in analyzing the question of fortuity, and noted that the damages that occurred in this case were within the control of Kay & Kay; Kay & Kay was hired to prevent the settling and resultant structural damage that occurred. “In other words, the possibility of the type of damage in this case was exactly what Kay & Kay was hired to control.” The Court reversed the judgment of the district court and remanded the case with instructions to grant judgment for Liberty Mutual.

Insured’s Settlement Without Consent Bars Coverage Under An OCIP

In its recent decision in Perini/Tompkins Joint Venture v. Ace Am. Ins. Co., 2013 U.S. App. LEXIS 24865 (4^th Cir. Dec. 16, 2013), the United States Court of Appeals for the Fourth Circuit, considering both Maryland and Tennessee law, had occasion to consider whether an insured’s settlement of an underlying construction defect claim, without its insurer’s consent, precluded its right to indemnification.

Perini/Tompkins Joint Venture (“PTJV”) qualified as a named insured under a primary and excess layer owner controlled insurance program (“OCIP”) issued by ACE American Insurance Company with respect to the construction of a $900 million hotel and convention center in Oxon Hill, Maryland.  A collapse of the hotel’s atrium during the construction process resulted in significant property delays.  Following completion of the project, PTJV sued the owner on various theories for approximately $80 million in unpaid work, and the owner brought a separate suit against PTJV based on various theories of negligence in connection with its construction management activities.  The owner’s sought damages in the amount of $65 million.  PTJV did not notify ACE of the countersuit, but later settled the litigation.  Pursuant to the settlement, the owner paid PTJV approximately $42 million and PTJV credited $26 million back to the owner.

Some six months after the settlement, PTJV demanded that ACE pay the $26 million shortfall.  ACE issued a reservation of rights on several grounds, including breach of the policies’ prohibition on settlements without ACE’s consent.  Specifically, the policies contained clauses stating that “No insured will, except at that insured's own cost, voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent.”  In the ensuing coverage litigation, the United States District Court for the District of Maryland granted summary judgment in ACE’s favor on the issue of voluntary payment. 

On appeal, PTJV noted that under Maryland law (which it argued governed the policies), Section 19-110 of the Maryland Code states that an insurer’s disclaimer of coverage based on an insured’s breach of a cooperation clause or notice clause will not be permitted unless the insured can demonstrate actual prejudice.  PTJV argued that ACE’s disclaimer of coverage based on a voluntary payment was tantamount to a disclaimer based on late notice, and that as such, ACE was required to demonstrate actual prejudice.  ACE, on the other hand, argued that its disclaimer of coverage was not based on untimely notice, but instead based on breach of the policies’ voluntary payment clause.  ACE argued that it would be unfair to require it to demonstrate prejudice, since having been shut out of the settlement negotiations, it would be “placed in the impossible situation of having to prove a negative.”

The Fourth Circuit agreed that "[t]he central issue in this appeal is whether the insured . . . can unilaterally settle a construction defect case . . . , present the settlement to its liability insurer as a fait accompli, and obtain indemnification despite its blatant breach of clear and unambiguous policy provisions.”  Looking to a Maryland state appellate court decision on the issue in Phillips Way, Inc. v. American Equity Insurance Co., 795 A.2d 216 (Md. Ct. Spec. App. 2002), the court concluded that Section 19-110 of the Maryland Code did not control the issue, and that ACE was not statutorily required to demonstrate prejudice in order to succeed on its motion for summary judgment.

The court also entertained PTJV’s alternative argument that prejudice must be demonstrated as a matter of common law.  In analyzing the question, the court looked to Maryland law, which is where the underlying events took place, and to Tennessee law, which is where the project owner resided and where the policies were issued.   The court found no precedent under Maryland law for the proposition that an insurer is required to demonstrate prejudice when an insured breaches a voluntary payment clause.  The court nevertheless observed that even if prejudice was a consideration, ACE was necessarily prejudiced by not having been afforded an opportunity to participate in the settlement discussions and by having been deprived of its opportunity to investigate, defend, control or settle the underlying suit.  Looking to Tennessee law, the court found no controlling authority from Tennessee’s Supreme Court on the issue, but nevertheless predicted based on lower court decisions that prejudice would not be a consideration, at least for settlements entered into prior to first notice to the insurer.

Wisconsin Appellate Court Holds Manure Not a Pollutant

In its recent decision in Wilson Mutual Ins. Co. v. Falk, 2013 Wisc. App. LEXIS 1031 (Wis. App. Dec. 11, 2013), the Court of Appeals for Wisconsin had occasion to consider whether cow manure generated at a dairy farm constitutes a pollutant for the purpose of a pollution exclusion.

Wilson Mutual issued a farmowners policy to Jane and Robert Falks, insuring their dairy farm operations.  The policy’s liability part contained an exclusion applicable to “losses resulting from the "discharge, dispersal, seepage, migration, release, or escape of  'pollutants' into or upon land, water, or air" as well as for "any loss, cost, or expense arising out of any … claim or suit by or on behalf of any governmental authority relating to testing for, … cleaning up, removing, … or in any way responding to or assessing the effects of ‘pollutants.’” The term “pollutant” was defined in the policy as “any solid, liquid, gaseous … irritant or contaminant, including … waste. Waste includes materials to be recycled, reclaimed, or reconditioned, as well as disposed of.”

In early 2011, the Falks began using manure generated by their cattle for crop fertilizer.  Their fertilizer plan was prepared by an agronomist and approved by their local county’s land and water conservation division.  Several months later, however, the Wisconsin Department of Natural Resources notified the Falks that manure runoff from their farm contaminated a local aquifer and polluted their neighbors’ wells.  These neighbors asserted claims against the Falks, who in turn sought coverage under their policy.  Wilson Mutual disclaimed coverage for the claims on the basis of its policy’s pollution exclusion.  In the ensuing coverage litigation, the trial court granted summary judgment in Wilson Mutual’s favor, concluding that cow manure constitutes waste for the purpose of the exclusion, and that the exclusion, therefore, barred coverage for the underlying claims.

On appeal, Wisconsin’s Court of Appeals agreed that manure came within the plain terms of the policy definition of “pollutant,” since manure “is certainly gaseous, often liquid, solid in winter, and can be both an irritant and a contaminant.”  (Emphasis in original.)  This, however, did not end the court’s inquiry, as it noted that in Peace v. Northwestern Nat'l Ins. Co., 596 N.W.2d 429 (1999), Wisconsin’s Supreme Court articulated a standard requiring a more exacting analysis of what constitutes a “pollutant,” since “there is virtually no substance or chemical in existence that would not irritate or damage some person or property.”  The Peace court reasoned that “the reach of the pollution exclusion clause thus must be circumscribed by reasonableness, lest everyday incidents be characterized as pollution and the contractual promise of coverage be reduced to a dead letter.”  In other words, determining whether a substance qualifies as a pollutant for the purpose of the exclusion must be viewed in terms of the understanding of a “reasonable person in the position of the insured.”

Looking to the holdings in Peace and its progeny, the court noted diverging results as to what substances qualify as pollutants.  For instance, Wisconsin courts have held that carbon monoxide released indoors is not a pollutant, whereas lead paint chips are properly considered a pollutant.  Further, in a 2012 decision, the Wisconsin Supreme Court held that bat guano would reasonably be considered a pollutant by a homeowner.  With these decisions in mind, the court reasoned that a dairy farmer likely would not cow consider manure to be a pollutant, explaining:

Manure is a matter of perspective; while an average person may consider cow manure to be "waste," a farmer sees manure as liquid gold. Manure in normal, customary use by a farmer is not an irritant or a contaminant, it is a nutrient that feeds the farmer's fields that in turn feeds the cows so as to produce quality grade milk. Manure in the hands of a dairy farmer is not a "waste" product; it is a natural fertilizer. While bat guano is "waste" to a homeowner, and lead paint chips are universally understood by apartment building owners to be dangerous and pollutants, manure is beneficial to a dairy farmer. Manure, by act of nature, has always been universally present on dairy farms and, if utilized in normal farming operations, is not dangerous

In reaching its holding that manure is not a pollutant and that the exclusion was inapplicable, the court noted that Wilson Mutual acknowledged the value of manure to the Falks, since the policy insured several pieces of equipment used in the manure fertilizer process; namely, the farm’s manure tank, the manure pump, manure spreaders and two manure tankers.  The court observed that by taking premium for this risk, Wilson Mutual expressed an understanding that manure spreading was a part of the Falks’ operations.  As such, explained the court, Wilson Mutual “cannot now seriously contend that paying claims related to the Falks' manure spreading is ‘a risk it did not contemplate and for which it did not receive a premium.’”

Florida Court Allows Rescission of a Professional Liability Policy

In its recent decision in Zurich American Ins. Co. v. Diamond Title of Sarasota, Inc., 2013 U.S. Dist. LEXIS 170981 (M.D. Fla. Dec. 4, 2013), the United States District Court for the Middle District of Florida had occasion to consider whether an insured’s guilty plea can be used as the basis for rescission of a professional liability policy.

Zurich insured Diamond Title under a title agent’s errors and omissions policy issued in 2007.  The owner/operator of Diamond Title was later indicted on several counts of mortgage fraud, conspiracy, bank fraud, wire fraud, and making false statements in connection with a loan application.  She later pled guilty to two counts, including conspiring to make materially false statements to banks and that she committed several acts of wire fraud.  Her plea agreement stated that the conspiracy ran from 2002 through 2008, the purpose of which was “to obtain loans secured by mortgages from FDIC-Insured banks and mortgage lending businesses.” 

Diamond Title was named as a defendant in an underlying suit relating to its duties as an escrow agent involving the purchase of distressed residential properties.  The suit alleged that Diamond Title negligently released money without prior authorization.  Zurich, in turn, sought rescission of the policy on the basis of material misrepresentations made in the insurance application.  Among other things, the application asked:

Does the Applicant or any prospective Insured know of any circumstances, acts, errors or omissions that could result in a professional liability claim against the Applicant? If "Yes", you must complete the attached claims addendum for each circumstance.

Zurich contended that at the time Diamond Title’s owner completed the application in 2007, and answered “No” in response, she was knowingly committing mortgage fraud and that she confirmed as much in her later plea agreement.   As such, Zurich maintained that Diamond Title should have answered “Yes” in response to the question.  The underlying claimant (named as a party to the rescission action), however, argued that Diamond Title’s response was truthful, since while at the time it was aware that it was committing criminal misconduct, it could not necessarily foresee civil liability for its actions.  In this connection, the claimant pointed out that the question inquired into acts that could result in professional liability claims, not criminal acts that would not come within the policy’s coverage in the first instance.   

Noting that the misconduct described in the plea agreement came within the policy’s definition of professional services, the court rejected the attempt to distinguish criminal misconduct from conduct that could give rise to a professional liability claim, explaining:

… the Court disagrees with the Defendant's assertion that criminal acts cannot result in claims for professional liability. A single act can be a basis for both professional and criminal liability. The Policy makes clear that it does not cover liability for criminal acts, even if they are properly characterized as professional liabilities. Rotolo [the owner of Diamond Title] was not relieved of her duty in the application to report acts that could result in a professional liability claim simply because the Policy may not have covered those acts. The Court concludes that Diamond Title's answer to question 21 of the Policy application, that it did not know of any circumstances that could result in a professional liability claim, was a misrepresentation.

The court further reasoned that the misrepresentation was material to the risk.  While the underlying claimant argued that Zurich failed to point to any underwriting guidelines applicable to the facts, the court relied on common sense reasoning that the insured’s failure to disclose a criminal conspiracy was material.  As the court explained:

The Court does not need an underwriter or guidelines to appreciate how not knowing Rotolo and her employee had been committing mortgage fraud in excess of five years left Zurich unable to adequately estimate the nature of risk in issuing the Policy. … As previously discussed, many of these acts could have resulted in claims against the Policy. An objective insurer may not have issued a policy at all. Certainly a policy would not have been issued under the same terms and pricing knowing that Diamond Title was engaged in an ongoing scheme to commit mortgage fraud.

Missouri Court Holds Underlying Fuel Tank Release Not Progressive Injury

In its recent decision in Stoddard Equipment Co., Inc. v. American Safety Indemnity Co., 2013 U.S. Dist. LEIS 170701 (W.D. Mo. Dec. 4, 2013), the United States District Court for the Western District of Missouri had occasion to consider whether property damage occurred during the policy period of a pollution liability policy.

American Safety’s insured, Stoddard, was named as a defendant in an underlying suit for its alleged negligent installation of a gas pipeline running from a storage tank to a marina where the gasoline was dispensed.  Stoddard completed the work in early October 2009.  The underlying plaintiff alleged that during the evening of September 2, 2011, the entire contents of its tank leaked into the surrounding soils and waters.  Plaintiff alleged that Stoddard’s negligent installation of the pipe in 2009 is what caused the release in 2011.

Stoddard sought coverage under various policies for the underlying suit, including a contractors’ pollution liability policy issued by American Safety for the period November 3, 2008 to November 3, 2009.  The policy’s insuring agreement provided coverage for property damage, but only to the extent the property damage occurred during the policy period.  American Safety denied coverage to Stoddard on the basis that the property damage, i.e., the damage caused by the release of the storage tank’s contents, happened in its entirety nearly two years after the expiration of its policy.  Stoddard nevertheless maintained that because the pipe was negligently installed during the time the American Safety policy was in effect, the property damage should be considered progressive in nature, spanning several policy periods.

On motion to dismiss, the court rejected Stoddard’s argument, distinguishing the gasoline release from matters involving property damage happening over a lengthy period of time, such as at issue in the Missouri Supreme Court case D.R. Sherry Const., Ltd. v. American Fam. Mut. Ins. Co., 316 S.W.3d 899 (Mo. 2010), which involved structural damage to a home over a period of years as a result of an unstable foundation.  The underlying complaint contained no allegation that the pipe installed by Stoddard began leaking prior to November 3, 2009, but instead alleged that the entirety of the leak happened during a one night period in September 2011.  The court further reasoned that no inference could be drawn from the complaint that any hole developed in the pipe prior to the expiration of the American Safety policy.  In reaching its holding, the court cited to the line of Missouri law “that draws a distinction between the occurrence of negligent act during the policy period and the occurrence of physical damage that results from the commission of a negligent act during the policy period.”  While the court agreed that Stoddard’s alleged negligence happened while the American Safety policy was in force, the resulting damage happened in its entirety after the expiration of the policy and thus fell outside of that policy’s scope of coverage.

Kentucky Court Holds Insurer Established Diversity Jurisdiction

In its recent decision in Capitol Specialty Ins. Corp. v. IKO, Inc., 2013 U.S. Dist. LEXIS 167933 (E.D. Ky. Nov. 26, 2013), the United States District Court for the Eastern District of Kentucky had occasion to consider whether an insurer’s declaratory judgment action satisfied the threshold requirements for diversity jurisdiction under 28 U.S.C. § 1332.

Capitol insured IKO, which owned a bar, under a general liability policy.  While the policy was subject to a general limit of liability of $1 million per occurrence, the policy contained an Assault Limitation endorsement setting forth a $25,000 sublimit applicable to loss arising out of assault or battery.  IKO was named as a defendant in an underlying state court lawsuit brought by a patron alleging that she was sexually assaulted by several of the bar’s patrons.  Capitol subsequently brought suit against IKO in federal court, seeking declarations: “(1) that the Assault Limitation ‘is the exclusive liability coverage form applicable to the claims asserted … in the underlying Complaint;’ (2) that Capitol's duty to indemnify IKO in the underlying state action is limited to the Assault Limitation's sub-limit of $25,000; and (3) that Capital has no duty to defend and indemnify IKO upon the exhaustion of the Assault Limitation's sub-limit of $25,000. “

IKO moved to dismiss, contending that Capitol failed to establish diversity jurisdiction under 28 U.S.C. § 1332.  IKO conceded that it and Capitol were not citizens of the same state, but it asserted that the amount in issue did not exceed the $75,000 jurisdictional threshold.  In particular, IKO contended that the object of the coverage action was the policy’s $25,000 sublimit of liability, and that because this amount was less than $75,000, Capitol failed to establish federal court jurisdiction.

In considering the issue, the court observed that the Sixth Circuit had “yet to decide whether the amount in controversy in a declaratory judgment action should be measured by the policy limits or by the value of the underlying claim.”  The court nevertheless drew from its own prior decision in Grange Mutual Casualty Co. v. Safeco Insurance Co., 565 F. Supp. 2d 779 (E.D. Ky. 2008), where it followed the rule applied by other circuit courts that “the policy limits are controlling in a declaratory action . . . as to the validity of the entire contract between the parties, but that when the applicability of an insurance policy to a particular occurrence is the question, the amount in controversy is measured by the value of the underlying claim.” 

While IKO argued that the sole issue in the declaratory judgment action was the validity of the sublimit, the court disagreed, reasoning that the issue was the application of the Assault Limitation endorsement to the underlying loss.  The court therefore concluded that the amount in controversy in the underlying action was the proper consideration for establishing diversity jurisdiction.  As such, and because plaintiff in the underlying lawsuit sought a recovery in excess of $2 million, the court agreed that Capitol successfully established the threshold requirements for diversity jurisdiction and that its lawsuit could proceed in federal court.

Texas Appellate Court Enforces Appraisal Provision

In a recent decision, the Court of Appeals of Texas for the Fourteenth District revisited the scope of the appraisal process in light of the prior holding in State Farm Lloyds v. Johnson, 290 S.W.3d 886 (Tex. 2009).

In In re Tex. Windstrom Ins. Ass’n, 2013 Tex App. LEXIS 11497, a homeowner, Joseph Hayden, sued Texas Windstorm Insurance Association (“TWIA”) to recover for property damage under an insurance policy it issued to him. Hayden alleged that his roof was damaged by hail and wind in April 2012. TWIA retained an independent adjuster to inspect Mr. Hayden’s roof, and the adjuster concluded that the damage was caused solely by wind.  TWIA subsequently advised Hayden that the damage did not exceed the deductible applicable to wind damage, and that as a consequence, Hayden would not receive policy benefits. Hayden’s insurance agent told TWIA in June 2012 that a contractor had inspected the roof and found more damage that would cost almost $15,000 to repair. TWIA retained an engineering firm in August 2012, and another inspection was conducted. Following this inspection TWIA advised Hayden that no policy benefits would be paid.  Hayden therefore advised of its intention to sue, and in response, TWIA demanded the roof first be appraised, relying on a policy provision which stated:

10.       Appraisal. If you and we fail to agree on the actual cash value, amount of loss, or cost of repair or replacement, either can make a written demand for appraisal.

Hayden refused TWIA’s appraisal demand and filed suit. TWIA filed a motion in the district court to compel appraisal, but the motion was denied. TWIA appealed the trial court’s denial of its motion to compel.

Hayden argued that appraisal was not appropriate because the dispute was over what caused the damage to the roof; a coverage issue for a court to determine. The Court disagreed, noting that TWIA also disputed the amount of loss. The court relied on State Farm Lloyds and concluded that the implication of a coverage issue pertaining to the claim did not automatically preclude appraisal. In its analysis the court explained that the appraisal provision could not be disregarded simply because coverage issues overlapped with the value of the loss.  The Court held that the trial court “clearly abused its discretion” when it denied TWIA’s motion to compel appraisal, and required the parties to appraise the loss.

Eighth Circuit Holds Customer Funds Exclusion Applicable

In its recent decision in Bethel v. Darwin Select Ins. Co., 2013 U.S. App. LEXIS 23183 (8^th Cir. Nov. 18, 2013), the United States Court of Appeals for the Eighth Circuit, applying Minnesota law, had occasion to consider the application of a customer funds exclusion in a professional liability policy.

Darwin insured Zen Title, a title insurance agency, under a claims made and reported professional liability policy.  One of Zen Title’s clients was United General Title Insurance Company ("UGT"), for whom Zen Title had responsibility for recording mortgages, deeds, and mortgage satisfactions and for paying fees associated with those recordings.  Zen Title’s responsibilities also including paying off mortgages on behalf of UGT and its customers in connection with mortgage refinancing transactions.  During the policy period, UGT terminated its relationship with Zen Title and brought suit against the company and its three principals. The court described the underlying complaint as alleging:

… a wide-ranging fraudulent scheme to misappropriate the funds entrusted to Zen Title by UGT. UGT alleged that "Zen, and the other Defendants associated with Zen and acting for same, deliberately chose to delay the recording [of mortgage instruments] so as to benefit from the pool of cash escrowed for the purpose of paying recording fees." In addition, Zen Title allegedly failed to use escrowed funds to pay off existing mortgages in mortgage refinancing transactions. The gravamen of UGT's allegations was that the defendants delayed recording mortgage instruments in order to retain and use funds that had been escrowed to pay fees associated with those recordings.

The complaint alleged several causes of action, including one for negligent failure to file various mortgage instruments in breach of Zen Title’s duties owed to UGT.

Zen Title tendered the suit to Darwin, and Darwin denied coverage on the basis of its policy’s customer funds exclusion, which barred coverage for “any Claim . . . based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any  way involving . . . any actual or alleged . . . loss, disappearance, pilferage or shortage of, or commingling or improper use of, or failure to segregate or safeguard, any client or customer funds, monies, or securities.”  In the ensuing coverage litigation, the United States District Court for the District of Minnesota granted summary judgment in favor of Darwin, concluding that the allegations in underlying complaint fell entirely within the exclusion.

On appeal, Zen Title argued that the cause of action for negligence potentially fell outside of the customer funds exclusion, such that Darwin at least had a duty to defend.  Darwin countered that when read in the context of the complaint, the cause of action for negligence was related to Zen Title’s alleged scheme of misappropriating escrow funds, and thus arose out of the excluded conduct.  The court agreed with Zen Title, observing that:

As described in UGT's complaint, the insureds failed to record mortgage instruments precisely so that they could divert the funds that would have had to be paid as filing fees at the time of recording. Thus, as alleged, the insureds failed to record mortgage instruments only because it constituted a necessary component of the broader scheme to misappropriate funds escrowed for filing fees. As such, there is a direct cause-and-effect relationship between all actionable conduct alleged in UGT's complaint and the loss or improper use of customer funds.

In reaching its holding, the Eighth Circuit rejected the insured’s attempt to divorce the cause of action for negligence from its context within the rest of the complaint.  While the court agreed that plaintiff could have filed a cause of action for negligence that had nothing to do with the alleged fraudulent scheme, the court could not ignore the actual allegations in the complaint.  As the court explained, “Minnesota's notice pleading rules did not require UGT to identify the specific circumstances under which each failure to record occurred, and so UGT's claims could possibly be premised on unspecified failures to record that are unrelated to the fraudulent scheme. This argument underestimates the significance of what UGT actually included in its complaint. UGT did specifically allege that the defendants failed to record mortgage instruments in order to facilitate the misappropriation of customer funds. UGT did not specifically allege any other failures to record.” 

The Eighth Circuit also rejected the insured’s argument that the customer funds exclusion rendered the policy’s coverage illusory, noting that the exclusion would not bar coverage for simple acts of negligence, such as failing to file a mortgage instrument or erring in doing so, since in such scenarios, the underlying actions would not involve the misappropriation of customer funds.  The court also rejected the argument by two of Zen Title’s principals that the wrongful acts of a third principal should not be attributed to them. The court held that the application of the exclusion did not depend on who committed the wrongful act, but instead on what gives rise to the underlying claim.  As the court explained:

The plain language of the exclusion makes clear that it applies regardless of whose conduct caused the loss or improper use of customer funds. … the Customer Funds Exclusion applies to any claim that arises out of any loss or improper use of client funds caused by anyone, be they a "guilty" insured, an "innocent" insured, or even a non-insured. It is irrelevant whether [the individual principals] participated in the wrongful conduct that triggered the Customer Funds Exclusion, so long as UGT's claims arose from some loss or misuse of customer funds.

Illinois Appellate Courts Issue Conflicting Additional Insured Decisions

Recently two different appellate courts in Illinois examined the issue of whether a subcontractor’s insurer is obliged to defend a general contractor as an additional insured. 

In Pekin Ins. Co. v. United Contr. Midwest, Inc., 2013 IL App 3d 120803, an employee of a Durdel & Sons Tree Service and Landscaping Inc. was injured when machinery that he was operating struck overhead power lines and electrocuted him. At the time, Durdel was operating as a subcontractor under Cullinan & Son, Inc., the general contractor. The injured employee filed suit against Cullinan for construction negligence and general negligence. Cullinan, in turn, filed a third party complaint alleging negligence against Durdel. Under the insurance policy issued to Durdel by Pekin Insurance Co., Cullinan was an additional insured, but only for vicarious liability as a result of Durdel’s work. Pekin denied coverage claiming the policy covered Cullinan for vicarious liability only and did not cover negligence resulting from Cullinan’s own actions. The trial court found in favor of coverage and Pekin appealed.

In Ill. Emasco Ins. Co. v. Waukegan Steel Sales, Inc., 2013 IL App (1st) 120735, an employee of I-Maxx Metal Works, Inc. was injured when a cable protection failed and caused him to fall. I-Maxx was a subcontractor of Waukegan Steel Sales, the general contractor. The employee brought suit against Waukegan and two other subcontractors for negligence. Those subcontractors then brought a third-party claim against I-Maxx, asserting contributory negligence. Under I-Maxx’s policy, issued by Emasco, Waukegan was named as an additional insured. Similar to the facts in Pekin, Emasco’s additional insured coverage was limited to vicarious liability. Emasco denied coverage stating that the allegations against Waukegan were for its own negligence. The trial court found that Emasco had a duty defend Waukegan as it could be found vicariously liable for the employee’s injuries.

Despite the relatively similar set of facts in these two cases, the courts arrived at different outcomes. In Pekin, the appellate court in the Third District refused to consider the third-party complaint filed by the putative additional insured. The opinion noted thatthe employee’s complaint against Cullinan did not allege direct negligence against the employer, and as a result, there could be no theory of vicarious liability against Cullinan. While the trial court looked beyond the underlying complaint to Cullinan’s third-party complaint, the appellate court refused to extend their analysis to Cullinan’s “potentially self-serving, third party complaint.”

The appellate court in the First District, however, did extend their analysis to the third-party complaints, reasoning that those claims were not brought by the putative additional insureds solely to bolster their demands for coverage. The court agreed that looking only to the employee’s complaint, there would be no additional insured coverage for vicarious liability under the Emasco policy. Extending the analysis beyond the underlying complaint, however, the court concluded that both of the third party complaints alleged negligence on the part of I-Maxx, for which Waukegan would potentially be vicariously liable. The court therefore held that Emasco had a duty to defend based on that potential.

Texas Court Holds Department of Insurance Proceeding Is a “Claim”

In its recent decision in Regency Title Co. v. Westchester Fire Ins. Co., 2013 U.S. Dist. LEXIS 162772 (E.D. Tex. Nov. 15, 2013), the United States District Court for the Eastern District of Texas had occasion to consider the date on which a claim was first made for the purpose of triggering coverage under a professional liability policy.

Westchester insured Regency Title Company (“Regency”) under a claims made and reported errors and omissions policy.  The policy defined the term “claim” to include:

1.   a written demand against any Insured for monetary or non-monetary damages;

4. a civil, administrative, or regulatory investigation against any Insured commenced by the filing of a notice of charges, investigative order, or similar document.

Subsequent to the policy’s issuance, Regency was named as a defendant in a lawsuit for alleged improper withdrawal of escrow funds in connection with an underlying real estate transaction.  A year prior to filing suit, however, plaintiff in the underlying action filed a complaint with the Texas Department of Insurance (“TDI”).  The TDI complaint involved the same facts as the later filed lawsuit, and it demanded payment of $100,000 or specific performance.  Subsequent to the filing of complaint with the TDI, but prior to the policy’s issuance, the TDI sent a letter to Regency advising of the complaint and of Regency’s opportunity to respond to the complaint.  Regency, in fact, answered the TDI complaint, and nearly a year prior to the inception of the Westchester policy, the TDI completed its investigation, concluding that Regency had not committed a violation of Texas Insurance Code. 

Westchester denied coverage to Regency for the underlying lawsuit on the basis that the claim was first made with the filing of the complaint with the TDI, and that the claim was made prior to the policy’s inception date.  In considering whether Westchester had a duty to defend Regency in the underlying matter, the court likened the “claims made” requirement to an exclusion that must be construed narrowly.  As such, explained the court, if there was any potential that the TDI complaint was not a “claim” as defined by the Westchester policy, then Regency would at the very least be entitled to a defense.

Regency argued that the TDI  complaint did not fall within the first definition of “claim,” of a written demand against any Insured for monetary or non-monetary damages, because the underlying plaintiff filed its complaint with the TDI and did not send any correspondence directly to Regency.   Specifically, Regency argued that “since the complaint was sent to a third party, the complaint does not constitute a ‘demand against an insured.’”  The court rejected this contention, noting that the policy’s first definition of claim only required a written demand “against any Insured,” not a written demand “sent to an insured.”  The court refused to read such an element into the definition of “claim,” finding it to be plain and unambiguous, explaining:

Regency is asking the court to add additional requirements to the definition in the policy. The policy does not indicate that the demand must be made directly to the insured. … The Exhibits indicate that Tower Custom Homes sent TDI a demand for money from Regency … that TDI sent that demand to Regency … that Regency responded directly to the demand … and that TDI sent Regency's response to Tower Custom Homes … .  Tower Custom Homes made a demand against Regency, Regency was informed of the demand, and Tower Custom Homes was informed that Regency was informed of its demand. Had Tower Custom Homes sent the demand to Regency through the U.S. mail with a return receipt requested, the exact same results would have occurred, except that Regency may or may not have sent Tower a response.

The court further observed that even if the TDI complaint did not constitute a written demand made against any insured, then it fell within the fourth definition of “claim” as a civil, administrative or regulatory investigation filed against the insured.  Regency argued that the TDI complaint did not fall within this definition of “claim” because TDI’s actions did not constitute an “investigation” within the meaning of the policy.  Specifically, Regency pointed to a phrase in TDI’s letter to Regency advising that it was “evaluating” whether Regency had committed a violation of the Texas Insurance Code.   Regency also argued that the brevity of TDI’s involvement (its file was closed within a matter of weeks) precluded its evaluation from being considered a formal investigation.  The court rejected this parsing of TDI’s actions, noting that the TDI’s letters made several references to its investigation, and that the duration of its investigation was irrelevant, since “the policy does not indicate that a detailed investigation or an exhaustive investigation must take place, but merely that there is an investigation.”  With this in mind, the court easily concluded that TDI’s actions came within the definition of “claim,” explaining:

…  TDI's actions are consistent with an investigation. TDI sent a letter to Regency asking specifically for information from Regency and that Regency supply TDI with "supporting documentation". … TDI was attempting to obtain information from Regency. Such an action could naturally be considered the first step in a "systematic examination", which is one definition for "investigation" that Regency has put forward. … Moreover, the very fact that TDI found no violation of the Texas insurance laws indicates that TDI must have conducted some type of investigation in order to make such a finding.

Accordingly, the court agreed that TDI action constituted a “claim,” and that as such, the “claim” against Regency was first made prior to the policy’s inception date.  The court, therefore, granted Westchester’s motion to dismiss, holding that it had no duty to defend or indemnify Regency in connection with the underlying lawsuit.

Louisiana Court Dismisses Excess Insurer’s Claim Against Primary Insurer

In its recent decision in RSUI Indem. Co. v. American States Ins. Co., 2013 U.S. Dist. LEXIS 161805 (E.D. La. Nov. 13, 2013), the United States District Court for the Eastern District of Louisiana had occasion to consider the duties owed by a primary insurer to an excess insurer.

Ameraseal was insured under a $1 million primary commercial auto policy issued by American States Insurance Company (“ASIS”) and a $5 million excess policy issued by RSUI.  Following an auto accident involving a vehicle owned by ASIS and being operated by an Ameraseal employee, a personal injury suit was filed against Ameraseal, the employee and ASIS.  RSUI was not named as a defendant.  Plaintiff settled with ASIS for the policy’s $1 million limit of liability, and a week later RSUI settled on behalf of its insureds, and itself, for $2 million.  As a result of the settlements, the matter never had to go to trial.

RSUI later brought suit against ASIS alleging bad faith failure to properly defend Ameraseal and the employee in the underlying matter.  RSUI claimed that had ASIS properly defended the case, then the loss would have remained in the primary insurance layer and RSUI would not have been required to pay $2 million.  ASIS countered that RSUI’s lawsuit was an impermissible means of stating legal malpractice claim against ASIS’ defense counsel.  ASIS further argued that it could not be liable in excess of its policy’s $1 million limit of liability since there was never an opportunity to settle the underlying matter within the policy’s limit of liability and since there was no excess verdict.  The court only considered ASIS’ latter argument.

Citing to Great Southwest Fire Insurance Co. v. CNA Insurance Companies, 557 So. 2d 966, 967 (La. 1990), the court acknowledged that under Louisiana law, a primary insurer owes a duty to an excess carrier to defend and to conduct settlement negotiations in good faith.  The court further noted, that while there was no controlling case law from Louisiana’s highest court as to whether such a claim can exist in the absence of a jury verdict, case law from the federal court level, including the Fifth Circuit, has consistently held that a verdict is a predicate for such a claim. RSUI argued that this case law was distinguishable, since its bad faith theory was not premised on a failure to settle, but instead was based on ASIS’ failure to properly defense the underlying suit, which resulted in a settlement value higher than necessary.  The court rejected RSUI’s theory, holding that even if such a distinction was relevant, RSUI would still be required to demonstrate an excess judgment as a necessary element of a bad faith claim against the primary insurer.

Florida Court Holds Criminal Conduct Exclusion In E&O Policy Applicable

In its recent decision in Certain Interested Underwriters at Lloyd’s v. AXA Equitable Life Insurance Company, 2013 U.S. Dist. LEXIS 159639 (S.D. Fla. Nov. 7, 2013), the United States District Court for the Southern District of Florida had occasion to consider the application of a criminal conduct exclusion in an insurance brokers professional liability policy.

Certain Interested Underwriters at Lloyd’s (“Lloyd’s”) insured Steven Brasner, an independent insurance broker, under an errors and omissions policy.  The underlying matter involved Mr. Brasner’s efforts to place life insurance coverage for his client, Geoffrey Glass.  Mr. Brasner proposed the purchase of two life insurance policies, one for $10 million and the other for $20 million, both of which would be purchased through insurance trusts established by Mr. Glass.  Mr. Brasner assisted with the processing of the policy applications, both of which were presented to AXA.  Among other things, both applications asked whether “Do you, the owner, intend to use or transfer the policy for any type of pre-death financial settlement, such as viatical settlement, senior settlement, life settlement, or for any other secondary market?”  Both applications answered this question in the negative.  AXA subsequently issued the two policies.  Only a few months later, however, the insurance trusts sold the policies to another entity – GIII – as investment vehicles.  It was later determined that Brasner, in fact, had falsified information on the applications, and had regularly done so, “to induce insurance companies to issue life insurance policies which would be held beyond the contestability period and then offered for sale on the secondary market.”

When Brasner’s schemes were discovered, AXA and other life insurance companies that had issued policies to Brasner’s clients, brought suits to rescind the policies.  The State of Florida also brought a criminal proceeding against Brasner.  Brasner ultimately pled guilty to several counts, including one that he had defrauded AXA by providing materially false information in the applications, including the applications submitted on behalf of Glass.  Several civil suits eventually followed, including one by GIII based on theories of negligent misrepresentation.  Brasner tendered the GIII matter to Lloyd’s, but Lloyd’s disclaimed coverage based on grounds.  Brasner and GIII later entered into a consent judgment for $1.45 million and an assignment of Brasner’s rights under the policy.

The first coverage defense asserted by Lloyd’s was that the conduct alleged did not fall within its policy’s definition of covered professional services, defined as “the marketing, sale or servicing of insurance products . . . .”  Lloyd’s argued that rather than selling insurance products, the GIII lawsuit related to Brasner’s sale of investment products.  The court found that while this argument might otherwise have merit, Lloyd’s failed to offer any evidence in support of this argument, thus precluding its right to summary judgment.

Lloyd’s also relied on a policy exclusion barring coverage for any claim:

… based upon, arising out of, directly or indirectly relating to or in any way involving . . . Falsification of any offer of an insurance contract or document, including but not limited to quotes, binders, indications or policies.

Lloyd’s argued that this exclusion should be read broadly enough to encompass falsification of any document, including insurance applications.  GIII, on the other hand, contended that documents identified in the exclusion, i.e., quotes, binders, indications, and policies, are all documents issued by insurers rather than by brokers, and that as such, the exclusion applied only to insurer communications.  The court found both interpretations of the exclusion to be reasonable, meaning that the term “document” as used in the exclusion was necessarily ambiguous and therefore must be construed in favor of coverage.

Finally, Lloyd’s relied on a policy exclusion barring coverage for claims:

… based upon, arising out of, directly or indirectly relating to or in any way involving . . . Conduct which is fraudulent, dishonest, criminal, willful, malicious, intentionally or knowingly wrongful, or otherwise intended to cause damage or injury to personal property; however, this exclusion shall not apply . . . unless there is a finding or adjudication in any proceeding of such conduct or an admission by an Insured of such conduct . . . .

Lloyd’s pointed to Brasner’s entry of a guilty plea, specifically with respect to the AXA policies, as to the basis for this exclusion’s application.  Looking to the plea deal, the court concluded that “[t]he totality of admissible evidence establishes conclusively that Brasner victimized AXA by making false and material misrepresentations on insurance applications.”  The court also found notable a portion of the plea agreement that allowed Brasner to continue receiving income from other prior placed policies, but prohibited him from receiving income the policies issued to Glass, thus further evidencing the fact that the Glass policies were part of Brasner’s scheme to defraud.  As such, and because these misrepresentations were central to Brasner’s efforts to resell the Glass policies to GIII, the court found the criminal conduct exclusion applicable to GIII’s lawsuit, and thus precluded coverage.

California Court Holds Insurer Entitled to Reimbursement of Defense Costs

In its recent decision in Great Am. Ins. Co. v. Chang, 2013 U.S. Dist. LEXIS 159197 (N.D. Cal. Nov. 6, 2013), the United States District Court for the Northern District of California had occasion to consider an insurer’s right to reimbursement of defense costs advanced to its insured for noncovered claims.

Great American insured Michael Chang under a series of general liability policies for his operation of a dry cleaner from 1977 through 1983.  Chang later sold the property to a third party and the property was converted to a restaurant.  That third party later brought suit against Chang when cleaning solvents were discovered on the property.  Great American agreed to prove Chang with a defense in the underlying suit, subject to a reservation of rights, including its right to seek reimbursement of defense costs associated with noncovered claims.  Great American ultimately paid $692,416 in defending the underlying suit, plus an additional $121,259 to perform a site investigation.  Great American also paid $70,426 in costs associated with defending Chang in connection with litigation with the California Regional Water Quality Control Board over whether the site remediation costs should be funded by California’s Underground Tank Storage Fund.  These legal fees were shared, in part, by Chang’s other insurers – Fireman’s Fund and Farmers – both of whom advanced defense costs pursuant to a reservation of rights.

Great American and Chang subsequently engaged in coverage litigation, and the court granted summary judgment in Great American’s favor as to its duty to defend and indemnify.  As a result of this decision, Great American moved for summary judgment on its right to reimbursement of the $884,000 in defense costs it advanced to its insured. 

Chang argued that Great American was not entitled to reimbursement of defense costs because its policies contained no language to this effect.  Chang argued in the alternative that Great American should be required to seek reimbursement of defense costs from Fireman’s Fund and Farmers.  Citing to Buss v. Superior Court, 939 P.2d 766 (Cal. 1997), the court rejected Chang’s first argument, observing that California law permits reimbursement of defense costs following a determination of noncoverage regardless of express policy language.  With respect to the second argument, the court noted that because Farmer’s and Firmeman’s Fund both had reserved rights, thus raising a question as to whether they ultimately had a duty to defend, Great American was entitled to recover directly from Chang.  As the court explained, “Great American should not have to seek reimbursement from third-party insurers, and potentially file another coverage action against those insurers, to recover costs that it advanced to the Changs.”  Thus, the court held that Great American was entitled to reimbursement of all defense costs plus prejudgment interest running from the date such amounts were paid.

California Court Addresses Superior Equities Rule

In its recent decision in San Diego Assemblers, Inc. v. Work Comp For Less Insurance Services, Inc., 2013 Cal. App. LEXIS 873 (Cal. App. 4^th Dist. Oct. 4, 2013), the California Court of Appeals had occasion to consider the application of the “superior equities rule” in an insurer’s subrogation action.

San Diego Assemblers, Inc. (“SDAI”), was a remodeling contractor that performed work for a restaurant in 2004.  In 2008, an explosion and fire occurred at the restaurant, resulting in property damage.  The restaurant’s property insurer (“Golden Eagle”) covered the claim, and promptly sued SDAI.  SDAI tendered the suit under its 2004 and 2008 liability policies, each issued by different general liability, but obtained through the same broker.  One of the policies, issued in 2004, contained a manifestation endorsement limiting to injury or damage first manifested during the policy period.  The other policy, issued in 2008, contained a prior completed work exclusion.  Both insurers, therefore, denied coverage.  A default judgment was obtained against SDAI, and SDAI subsequently assigned to Golden Eagle its rights against its broker. 

In the ensuing subrogation lawsuit, the broker argued that Golden Eagle’s subrogation claim was barred by the “superior equities rule,” which states that “‘one who asserts a right of subrogation, whether by virtue of an assignment or otherwise, must first show a right in equity to be entitled to such subrogation, or substitution.” Under this doctrine, explained the court, an insurer cannot establish a superior equitable position against a third party, if that third party is not the wrongdoer or legally responsible for the underlying loss.  The court therefore concluded that because the broker did not cause the underlying fire, and because the broker did not otherwise have an obligation to indemnify SDAI for the underlying loss Golden Eagle’s subrogation claim was barred by the superior equities doctrine.  That the claim was assigned by SDAI did not change the court’s analysis, since an assignment of rights cannot overcome the superior equities rule.  Relying on prior California case law on the issue, the court explained:

[W]here by the application of equitable principles, a surety has been found not to be entitled to subrogation, an assignment will not confer upon him the right to be so substituted in an action at law upon the assignment. His rights must be measured by the application of equitable principles in the first instance, his recovery being dependable upon a right in equity, and not by virtue of an asserted legal right under an assignment.

First Circuit Holds Prior Knowledge Exclusion Applicable

In its recent decision in Clark School for Creative Learning, Inc. v. Philadelphia Indemnity Ins. Co., 2013 U.S. App. LEXIS 21568 (1^st Cir. Oct. 23, 2013), the United States Court of Appeals for the First Circuit, applying Massachusetts law, had occasion to consider the application of a known circumstances exclusion in a directors and officers policy.

Philadelphia Indemnity Insurance Company (“PIIC”) insured the Clark School (the “School”) under a claims made and reported D&O policy issued for the period July 1, 2008 to July 1, 2009.  The Clark School is a non-profit, private school located in Danvers, Massachusetts. In May 2008, as a direct result of the School’s precarious financial difficulties, the School received a $500,000 donation from a family of three enrolled students, subject to the conditions that the family would receive a security interest in the land on which the School is located and that the funds would be used to construct a new high school.  The donation was reflected in a financial statement published prior to the inception date of the PIIC policy.  In May 2009, the family sued the School and its director for failing to satisfy these conditions.  It was alleged that the School’s director caused the School to pay $175,000 of the donated funds to his own mother and sister “purportedly for the repayment of loans.”

PIIC’s policy contained a manuscript exclusion titled Known Circumstances Revealed In Financial Statement Exclusion, which stated:

[T]he Underwriter shall not be liable to make any payment for Loss in connection with any Claim made against the Insured based upon, arising out of, directly or indirectly resulting from or in consequence of, or in any way involving any matter, fact, or circumstance disclosed in connection with Note 8 of the Financial Statement . . . submitted on behalf of the Insured.

Note 8 of the financial statement referred to in this exclusion specifically described the School’s financial difficulties and the $500,000 donation:

Subsequent to the date of the accompanying financial statement, in May of 2008 the School was a recipient of a major gift totaling $500,000 (see Note 7). The donation is unrestricted and will be used to support the School's general operations as management's plans for the School's future are implemented and allowed time to succeed. Management feels that its plans and the subsequent major gift will enable the School to operate as a going concern.

Note 7, referenced in this paragraph, made further reference to the $500,000 donation.

PIIC disclaimed coverage to the School for the underlying suit on the basis of this exclusion, and in the ensuing coverage litigation, the United States District Court for the District of Massachusetts ruled in PIIC’s favor.  On appeal, the School argued that the exclusion should be read to relate solely to the School’s financial difficulties and not to and claims involving the donation.  The School also argued that various rules of contract construction, including the concept of reasonable expectations, required a more limited reading than applied by the lower court. 

The First Circuit disagreed with the School’s arguments regarding the exclusion, observing that it was plain and unambiguous on its face.  With respect to the School’s argument that the exclusion should be limited to financial difficulties alone, the court concluded that the reference in Note 8 to $500,000 donation, as well as to Note 7, which also described the donation, indicated that the exclusion could not be read as being limited to losses resulting from the School’s financial difficulties.  The court also rejected the School’s argument that the phrase “in any way involving” as used in the exclusion must include a “causal element,” and that the underlying loss was not caused by the donation.  The court the phrase “in any way involving” to represent “a mop-up clause intended to exclude anything not already excluded by” the other terms of the exclusion.  Regardless, the court held that even if a causation element was required, this was more than satisfied as the underlying loss was caused by the School’s misrepresentations concerning the donations.   Finally, the court rejected the School’s reasonable expectations argument on the basis that the exclusion was not ambiguous and that there could be no reasonable uncertainty as to what its scope.