Illinois Court Addresses Liquor Liability Exclusion

In its recent decision in Netherlands Insurance Co. v. Phusion Projects, Inc., 2012 U.S. Dist. LEXIS 5222 (N.D. Ill. Jan. 17, 2012), the United States District Court for the Northern District of Illinois had occasion to consider the application of liquor liability exclusion.

The insured, Phusion Projects, produced and sold an alcoholic beverage that also contained significant quantities of “stimulants” such as caffeine, wormwood and taurine.  Phusion was named as a defendant in several product liability suits brought by individuals claiming injuries as a result of having consumed the beverage.  While the nature of plaintiffs’ injuries differed, all suits alleged, in pertinent part, that the combination of alcohol and stimulants in the Phusion beverage enabled plaintiffs to consume more alcohol without passing out, thus causing them to behave more erratically while intoxicated and/or causing them to suffer negative health effects.

Phusion’s primary and umbrella liability insurers denied coverage for the underlying suits on the basis of a liquor liability exclusion applicable to:

c. Liquor Liability

"Bodily injury" or "property damage" for which any insured may be held liable by reason of:

   (1) Causing or contributing to the intoxication of any person;

   (2) The furnishing of alcoholic beverages to a person under the legal drinking age or under the influence of alcohol; or

    (3) Any statute, ordinance or regulation relating to the sale, gift, distribution or use of alcoholic beverages.

This exclusion applies only if you are in the business of manufacturing, distributing, selling, serving or furnishing alcoholic beverages.

Phusion argued that the exclusion should not apply since the policies were purchased specifically to insure Phusion’s products, which the insurers knew were alcoholic, thus rendering coverage virtually nonexistent.  The court rejected this argument, explaining that the policies provided coverage for other risks arising from Phusion’s products, such as “if Phusion sold tainted products and injured its customers in a manner unrelated to intoxication.”  Phusion also argued that the exclusion applied only to “Dram shop” claims, i.e., liability against bars for their sale of alcohol to individuals who then cause injuries to others.  The court rejected this argument as well, citing to the express language of the exclusion that broadly applied to any insured in the business of manufacturing, distributing and selling alcoholic beverages, not just those in the business of serving or furnishing such beverages.

Thus, finding the exclusion clear and unambiguous, the court concluded that the exclusion applied to four of the underlying suits alleging injuries as a result of plaintiffs being intoxicated, including a DUI-related suit and a suit alleging that an individual accidentally killed himself after his consumption of the Phusion beverage caused him to be awake, in an intoxicated state, for over thirty hours.  The court did, however, conclude that the exclusion did not apply to an underlying suit alleging that plaintiff developed a heart condition as a result of consuming the Phusion product since the his claim was based on the dangerous nature of the product rather than its intoxicating nature.

California Court Holds Professional Services Exclusion Ambiguous

In its recent decision in Corky McMillin Construction Services, Inc. v. U.S. Specialty Ins. Co., 2012 U.S. Dist. LEXIS 3438 (S.D. Cal. Jan. 11, 2012), the United States District Court for the Southern District of California considered the application of an errors and omissions exclusion contained in a directors and officers insurance policy.

At issue in Corky McMillin was the insured’s right to coverage for an underlying class action.  Plaintiffs in the suit alleged that the insured, Corky McMillin, made various misrepresentations and omissions regarding the nature, value and desirability of certain residential neighborhoods. The policy provided coverage for “Insured Organization Loss arising from Claims first made against [the insured] during the Policy Period or Discovery Period (if applicable) for Wrongful Acts.” By endorsement, however, the policy contained an errors and omissions exclusion, stating in relevant part that:

… the Insurer will not be liable to make any payment of Loss in connection with any Claim against the Insured Organization arising out of, based upon or attributable to the rendering or failure to render services for others, including without limitation services performed for or on behalf of customers or clients of the Insured Organization … .

U.S. Specialty denied coverage on the basis of this E&O exclusion. Corky McMillin argued that the exclusion was ambiguous since the term “services” was not defined in the policy. U.S. Specialty countered, and the court agreed, that the term “services” should be interpreted based on its common dictionary definition, meaning “the work performed by one that serves.” The court further agreed with U.S. Specialty that while this definition of “services” was broad, the mere breadth of the term did not otherwise render it ambiguous.

The court nevertheless found the exclusion as a whole to be ambiguous when considered in the context of the policy’s insuring agreement, which provided coverage for “wrongful acts,” defined in pertinent part as “any other actual or alleged act, error, misstatement, misleading statement, omission or breach of duty (a) by the Insured Organization … .” The court noted that while the intent of the E&O exclusion was to bar coverage for liability arising out of the insured’s services, it was not clear whether “services,” with its broad meaning, encompassed, and therefore excluded, the same “wrongful acts” covered under the policy’s insuring agreement.  For instance, explained the court, while the definition of “wrongful act” included misstatements, misleading statements and omissions, the exclusion, on its face, would operate to bar coverage for misstatements, misleading statements and omissions contained in the insured’s marketing materials – the very basis on which the insured was sued in the underlying suit. Given the “canons of construction” that insuring agreements are to be interpreted broadly in favor of the insured and that exclusions are to be interpreted narrowly against the insurer, the court concluded that “there is, at a minimum, ambiguity about the meaning of the term ‘services’ as used in the E&O Endorsement.”

Supreme Court of Utah Addresses Allocation of Defense Costs Among Insurers

In a question certified by the United States Court of Appeals for the Tenth Circuit, the Supreme Court of Utah in The Ohio Casualty Ins. Co. v. Unigard Ins. Co., 2102 Utah LEXIS 1 (Utah Jan. 6, 2012) recently addressed the issue of whether allocation among successive insurers is determined by the insurers’ respective “other insurance” clauses or by a time-on-the-risk methodology.

The insured, Cloud Nine, had general liability coverage from Ohio Casualty for a one-year period, and then from Unigard for the next three years.  Cloud Nine was sued for an alleged advertising injury which allegedly took place during the last three months of the Ohio Casualty policy, continued throughout the entire period of the Unigard policy, and extended into a period of time in which Cloud Nine was not insured.  Ohio Casualty denied coverage and commenced a declaratory action in which Unigard eventually was a party.  The Utah federal district court held that Ohio Casualty indeed had a duty to defend Cloud Nine and that defense costs must be shared equally with Unigard as a result of their policies’ respective “other insurance” clauses.  Ohio Casualty appealed the question of allocation to the Tenth Circuit, which in turn certified the question to the Supreme Court of Utah.

Ohio Casualty argued on appeal that pursuant to the decision by the Supreme Court of Utah in Sharon Steel Corp v. Aetna Casualty & Surety Co., 931 P.2d 127 (Utah 1997), defense costs should be allocated based on a time-on-the risk methodology, and that Cloud Nine should be allocated a percentage of defense costs for its uninsured period.  Unigard, on the other hand, argued that allocation should be determined by the policies’ other insurance clauses, both of which stated that in the event of other insurance, the policies provide primary coverage on an equal shares basis. 

The court rejected Unigard’s argument, concluding that “other insurance” clauses do not apply to successive insurers, but only to concurrent insurers.  As such, the court explained, the matter was governed by its prior holding in Sharon Steel, which applied a time-on-the-risk methodology in the context of an environmental claim, rather than an equal shares methodology.  In explaining the basis for its prior holding, the court noted that such an allocation scheme “was the most equitable because it fairly related both to the time each insurer spent on the risk and the degree of risk each insurer contracted to assume.”  Thus, while the court agreed with Unigard that Ohio Casualty had an absolute duty to defend Cloud Nine, it noted that the “duty to defend and the apportionment of defense costs between two insurers that have an equal duty to defend are distinct issues.”  As such, the court concluded that defense costs should be apportioned based on time-on-the risk, subject to policy limits.

The court did, however, reject Ohio Casualty’s argument that Cloud Nine should be made to participate in its own defense.  The basis for the court’s reasoning was that both Ohio Casualty and Unigard, pursuant to their respective policies, assumed complete control over Cloud Nine’s defense.  As a result, the court concluded, “it would be inequitable to apportion any defense costs to an insured who has no power to select counsel or negotiate rates and no voice in deciding whether to settle the suit.”  Thus, the court held that defense costs would be divided between Ohio Casualty and Unigard based on their respective times on the risk and that “the portion of defense costs attributable to periods during which the insured lacked coverage” would be divided among the two insurers “in the same proportions.”

California Court Addresses Payment of Self-Insured Retention

In its recent decision in National Fire Ins. Co. of Hartford v. Federal Ins. Co., 2012 U.S. Dist. LEXIS 641 (N.D. Cal. Jan. 4, 2012), the United States District Court for the Northern District of California had occasion to consider the issue of whether an insured was required to satisfy a self-insured retention with its own funds, or whether the retention could be paid by other insurance.

The insured in National was a restaurant located within a hotel.  The restaurant hosted a graduation party at which a three-year old girl fell to her death from a balcony.  The girl’s family brought a wrongful death suit, initially against the hotel only, which was insured by Federal Insurance Company.  The hotel tendered its defense to National, the primary insurer for the restaurant, on the basis that the hotel qualified as an additional insured under the restaurant’s policy.  While National initially denied coverage to the hotel, it later paid its policy limit to plaintiffs in order to secure a settlement on behalf of the restaurant and the hotel.  National then brought a contribution claim against Federal. 

After finding that the hotel was, in fact, entitled to additional insured coverage under the policy National issued to the restaurant, the court addressed the issue of priority of coverage as between the National and Federal policies, and the related issue of whether payments made by National on behalf of the hotel satisfied the Federal policy’s self-insured retention.  The Federal policy had a $250,000 self-insured retention and the policy provision concerning payment of the retention stated that “[w]e have no obligation or liability under such Coverages unless and until the applicable Self-Insured Retentions … are exhausted by payments you make … You must pay all self-insured retention expenses.”  Thus, from the face of this provision, only the insured could pay the retention.

Citing to the 2010 California state court decision in Forecast Homes, Inc. v. Steadfast Ins. Co., 181 Cal. App. 4^th 1466 (Cal. App. 2010), Federal argued that this policy language required the hotel to pay the retention with its own funds, and that the retention could not be insured.  The court rejected this argument, however, noting that in Forecast Homes, the provision concerning payment of the self-insured retention expressly stated that “Payment by others, including but not limited to additional insureds or insurers, do not serve to satisfy the self-insured retention.”   By contrast, the Federal policy contained a “Bankruptcy Within the Self-Insured Retention” provision stating that the bankruptcy of any insurer, or any other person, would not relieve the hotel of its obligation to satisfy the retention.  This language, explained the court, implied that the retention could be paid by other insurers, or other persons, and at the very least, did not “clearly require the hotel to satisfy the SIR out of its own pocket.”  In other words, the bankruptcy provision negated the otherwise clear policy provision stating that the retention must be paid by “you.”

This aspect of the National Fire decision adds to the body of California case law dating back to General Star Nat. Ins. Corp. v. World Oil Co., 973 F. Supp. 943 (C.D. Cal. 1997) and Vons Cos. v. United States Fire Ins. Co., 78 Cal. App. 4th 52 (Cal. App. 2000), and more recently in cases such as Forecast Homes, Mt. McKinley Ins. Co. v. Swiss Reinsurance Am. Corp., 757 F. Supp. 2d 952 (N.D. Cal. 2010); Travelers Indem. Co. v. Arena Group 2000, L.P., 2007 U.S. Dist. LEXIS 17931 (S.D. Cal. 2007).  These cases establish the general rule that absent express and unambiguous language restricting payment of a retention to the insured, California courts will allow retentions to be satisfied by secondary sources, including other insurance.  

New York Court Addresses Impact of Allowing Insured to Default

The recent decision by New York’s Appellate Division, First Department, in K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co., 2012 N.Y. App. Div. LEXIS 16 (Jan. 3, 2012) illustrates the dangers under New York law in denying a duty to defend, and allowing an insured to default, when coverage is questionable.

The underlying matter in K2 involved a convoluted factual scenario, complicated by the insured’s default.  Plaintiffs, K2, were a group of limited liability companies that made a series of loans to non-party Goldan, LLC.  Goldan’s principal was Jeffrey Daniels.  Mr. Daniels also happened to be an attorney, and in this capacity, he represented K2 in connection with the loan to Goldan.  How or why K2 agreed to be represented by Mr. Daniels despite the apparently obvious conflict of interest was not explained by the court.  After the loans were made, Goldan became insolvent and defaulted on the loans, whereupon K2 learned that Mr. Daniels had failed to properly secure the loans with mortgages and had failed to obtain title insurance. 

K2 subsequently brought a malpractice action against Mr. Daniels and demanded $450,000 to settle their claims, which was within the $2 million limit of liability on Mr. Daniels’ legal malpractice policy issued by American Guarantee.  American Guarantee nevertheless denied coverage to Mr. Daniels based on two policy exclusions: one applicable to claims based upon or arising out of the insured’s capacity as an officer or director of a business enterprise and the other applicable to acts or omissions of the insured for any business enterprise in which the insured had a controlling interest.  American Guarantee’s argument, therefore, was that the exclusions applied because Mr. Daniels represented K2 in connection with loans made to a company in which he was a principal.  Mr. Daniels failed to appear in K2’s lawsuit, resulting in a default judgment in the amount of $688,716.  Following entry of the judgment, Mr. Daniels assigned his rights under the policy to K2, including bad faith claims.  K2 thereafter brought a direct action against American Guarantee.

The court explained that having allowed its insured to default, American Guarantee could litigate the application of the exclusions, but could not otherwise challenge the underlying or damages determination, citing to Lang v. Hanover Ins. Co., 787 N.Y.S.2d 211 (N.Y. 2004) and Rucaj v. Progressive Ins. Co., 797 N.Y.S.2d 79 (N.Y. 1^st Dep’t 2005).  The court nevertheless concluded that the exclusions relied on by American Guarantee did not apply since K2’s suit related to Mr. Daniels’ capacity as their own lawyer rather than his capacity as a director or officer of Goldan.  The court noted that by having failed to defend its insured, American Guarantee “cannot at this juncture assert defenses that would have defeated the legal malpractice claims (for example, that Daniels was not performing legal services for plaintiffs but instead was representing Goldan) or would have established the applicability of the exclusions … .”  In other words, the court suggested that there were facts that would have either refuted K2’s malpractice claim, or that could have supported application of the policy exclusions, but by having allowed its insured to default, American Gurantee could not rely on or seek to discover such facts, and instead was limited to the allegations in the complaint in support of its policy exclusions.

In passing, the court rejected K2’s claim for bad faith, holding that under Pavia v. State Farm Mut. Auto Ins. Co., 82 N.Y.2d 445 (N.Y. 1993), K2 failed to demonstrate American Guarantee’s “gross disregard” of its insured’s interests under the policy.

New York Court Holds Disgorgement Payment Not Covered Under Professional Liability Policies

In its recent decision in J.P. Morgan Securities, Inc. v. Vigilant Ins. Co., 2011 N.Y. App. Div. 8829 (N.Y. 1^st Dep’t Dec. 13, 2011), the New York Appellate Division for the First Judicial Department considered whether a disgorgement payment made pursuant to a settlement with the SEC qualified for coverage as compensatory damages under the insureds’ professional liability coverage program.

The insureds, various Bear Stearns entities, had been the subject of an SEC investigation in connection with its alleged practices of facilitating late trading and engaging in deceptive market timing for certain favored customers.  While Bear Stearns did not admit to liability, it ultimately settled with the SEC by agreeing to a disgorgement payment in the amount of $160 million and a civil penalty payment in the amount of $90 million.   

Bear Stearns sought indemnification for the settlement amount under its primary and excess layer professional liability policies that provided coverage for “Loss which the insured shall become legally obligated to pay as a result of any Claim … for any Wrongful Act on its part.”  “Loss” was defined by the policies as including compensatory damages and costs associated with defending an governmental investigation, but expressly carved out “(i) fines or penalties imposed by law; or … (v) matters which are uninsurable under the law pursuant to which this policy shall be construed.”  The policies also excluded coverage for claims “based upon or arising out of any deliberate, dishonest, fraudulent or criminal act or omission.”  Bear Stearns insurers disclaimed coverage for the disgorgement payment on the basis that it did not fall within the definition of “Loss” and that it was otherwise excluded. 

Bear Stearns subsequently commenced coverage litigation against its insurers, and the trial court denied the insurers’ motion to dismiss.  Bear Stearns argued that while the $160 million payment to the SEC was labeled a “disgorgement payment,” it nevertheless should be considered compensatory damages for the purpose of the policies’ definition of Loss.  The court held that a question of fact existed as to whether the disgorgement payment was exclusively linked to improperly acquired funds.  Specifically, the lower court found that there was nothing in the SEC Order or the related documents from which to conclude that Bear Stearns directly profited from the alleged violations, or that it earned $160 million as a result of its conduct. 

On appeal, the Appellate Division reversed, concluding that the facts established that Bear Stearns’ offer of settlement, the corresponding SEC Order, and various other documents, established that Bear Stearns “knowingly and intentionally facilitated illegal late trading for preferred customers, and that the relief provisions of the SEC Order required disgorgement of funds gained through that illegal activity.”   Among other things, the SEC Order demonstrated Bear Stearns’ falsification of order tickets and its use of dummy account and trader numbers to conceal late trades.  The Order also determined that Bear Stearns “willfully violated, willfully aided and abetted and caused” numerous securities violations.  As such, the Appellate Division concluded that it “cannot be seriously argued that Bear Stearns was merely found guilty of inadequate supervision and a failure to place adequate controls on its electronic entry system.”

The Appellate Division also rejected Bear Stearns contention that an issue of fact was raised as to whether the entirety of the $160 million disgorgement payment related to ill-gotten gains.  While the SEC Order did not specifically itemize how the $160 million disgorgement figure was determined, explained the court, it also did not raise a possibility that the amount, or at least a portion of it, was compensatory in nature. A disgorgement payment need not be specifically calculated, noted the court, but need only be a “reasonable approximation of profits casually connected to the violation.”

4th Circuit Holds No Duty to Defend Insurance Broker In Bodily Injury Suit

In its recent decision in Houston Cas. Co. v. St. Paul Fire & Marine Ins. Co., 2011 U.S. App. LEXIS 24157 (4^th Cir. Dec. 6, 2011), the United States Court of Appeals for the Fourth Circuit, applying South Carolina law, considered whether a general liability insurer had a duty to defend its insured, an insurance broker, in connection with an underlying construction site injury lawsuit.

The insured, McGriff, Seibels & Williams, Inc. (“McGriff”), was the broker of record for an owner-controlled insurance program (“OCIP”) issued to provide coverage for claims arising out of dam construction project.  As part of its services, McGriff distributed a document called “Manual of Insurance Procedures” to the various contractors covered under the OCIP policy.  The Manual expressly stated that McGriff, in conjunction with the project’s general contractor, would have various safety-related responsibilities in connection with the project. 

McGriff was named as a defendant in a suit brought by an individual who suffered catastrophic injuries while working on the project.  Plaintiff alleged causes of action for negligence and breach of contract against McGriff on the basis that it had assumed responsibiliy for performing inspections at the work site to ensure that it was reasonably safe, but failed to perform these inspections.  McGriff’s professional liability carrier, Houston Casualty Company, undertook McGriff’s defense.  St. Paul, however, which was McGriff’s general liability carrier denied coverage on the basis of an “Insurance and Related Work” endorsement, stating:

We won't cover injury or damage or medical expenses for which the protected person may be held liable because of:

• any obligation assumed by any protected person in connection with an insurance contract or treaty; [or]

• any failure to carry out, or improper carrying out of, any contractual or other duty or obligation in connection with an insurance contract or treaty.

Houston brought a contribution action against St. Paul, alleging that St. Paul had a duty to defend and McGriff in the underlying suit.  The trial court granted summary judgment in St. Paul’s favor, agreeing that the exclusion applied because McGriff was sued “in connection with an insurance contract.”  On appeal, Houston argued that McGriff’s safety-related duties in connection with the project existed independent of the insurance contract, and thus did not fall within the scope of the exclusion.  More specifically, Houston argued that plaintiff’s negligence claim against McGriff was based upon a common law duty arising from a voluntary undertaking of various safety-related duties, and that plaintiff’s breach of contract claim did not allege breach of an insurance contract.

The court rejected Houston’s broad reading of the complaint, pointing out that the exclusion applied to any failure to carry out any contractual or other duty in connection with an insurance contract.  As such, the court explained, the exclusion would apply to a breach of any contract claim, even one other than the insurance policy itself, so long as the additional contractual obligation arose “in connection with” an insurance contract.  The court further explained that as long as McGriff’s common law obligations would fall within the exclusion as long as those obligations arose “in connection with” an insurance contract.

Looking to the complaint, as well as the Manual, the court concluded that McGriff’s contractual and common law obligations were related to and stemmed from its efforts to issue the OCIP.  While McGriff assumed various obligations outside of the OCIP, it did so as part of its efforts to broker the program, and thus arose “in connection with” the policy.  As such, the Fourth Circuit affirmed the grant of summary judgment, finding persuasive the lower court’s statement that “there is no allegation or suggestion in the complaint that McGriff assumed any safety-related duties except in this role [i.e., as the broker of record].”