In This Issue:

• Insurer Should Have Considered Extrinsic Facts When Determining Whether a Potential for Coverage Existed, Ninth Circuit Concludes

• Court Finds Coverage for Suit Over Termination of Breast Cancer Vaccine Program; Settlement Does Not Represent “Disgorgement”

• Tenth Circuit: Even If Insured Waited Too Long In Giving Notice, Insurer Suffered No Prejudice

• Insured Not Required to Exhaust All Remedies Against Perpetrators of Fraud, Court Rules

Insurer Should Have Considered Extrinsic Facts When Determining Whether A Potential for Coverage Existed, Ninth Circuit Concludes

Why it matters
In a fascinating – albeit unpublished – decision from the Ninth U.S. Circuit Court of Appeals, two judges on the appellate panel reversed summary judgment for an insurer that had failed to consider facts extrinsic to the underlying complaint when denying coverage to the policyholder. According to the majority, a police report and witness statements provided by the insured offered an alternative theory of the plaintiff’s case that removed it from the application of a policy exclusion. Because the extrinsic facts available to the insurer indicated the potential for coverage, that was sufficient to trigger the duty to defend, the court held.

Detailed Discussion
Rudy Martinez, a patron at the Crazy Horse Restaurant and Nightclub, filed suit after he was allegedly injured by the bar’s security guards.

In addition to the complaint, Crazy Horse sent insurer Burlington Insurance Co. a copy of the police report, which contained multiple witness statements from the night in question. Some of the witnesses told police that Martinez was injured not by the security guards but when he tried to sit down on a stool and lost his footing, hitting his head on the wall.

According to Burlington, the allegations in Martinez’s complaint against the security guards brought it within a policy exclusion for injuries “[a]rising out of assault or battery, or out of any act or omission in connection with the prevention or suppression of an assault or battery.”

Burlington denied defense coverage and a federal district court granted the insurer summary judgment on the ground that it had no duty to defend or indemnify.

On appeal, the Ninth Circuit reversed, relying upon the police report and attached witness statements that “also contained facts indicating that Martinez’s injuries might have been caused by events that would not fall within the assault-or-battery exclusion. Those extrinsic facts, which Burlington was obligated to consider in making its coverage decision, triggered a duty to defend because they reveal[ed] a possibility that the claim may be covered by the policy.”

If the witnesses were correct that Martinez fell from a stool, that version of events would not fall within the exclusion, the court said. “Thus, the extrinsic facts available to Burlington indicated the potential for coverage, which is all that was necessary to trigger its duty to defend,” the panel wrote.

The court acknowledged that extrinsic facts cannot trigger the defense duty when they relate only to claims that have not been pleaded in the third-party claimant’s complaint.

“But here the extrinsic facts at issue do relate to a claim pleaded in Martinez’s complaint – namely, his negligence claim,” the court said. “Although as originally pleaded Martinez’s negligence claim was predicated on the theory that he had been assaulted, the extrinsic facts available to Burlington revealed the possibility that Martinez could amend his negligence claim to allege theories of liability that would fall outside the assault-or-battery exclusion. Under well-settled California law, that possibility was enough to trigger Burlington’s duty to defend.”

To read the decision in The Burlington Insurance Co. v. CHWC, click here.

Court Finds Coverage for Suit Over Termination of Breast Cancer Vaccine Program; Settlement Does Not Represent “Disgorgement”

Why it matters
Did the decision to terminate a breast cancer vaccine program constitute a wrongful administrative act or involve medical or professional services? When falling on the side of a medical and professional service, a recent holding from the Illinois Court of Appeals meant coverage from one insurer for the insured medical educational institution and the application of an exclusion from a second. The court additionally held that the primary insurer waived its right to argue that it did not consent to an underlying settlement when it failed to timely object to the deal, despite knowledge of the settlement negotiations.

Detailed Discussion
The dispute began with a decision by nonprofit educational institution Rosalind Franklin University of Medicine to stop an experimental breast cancer vaccine program. Former patients sued. Despite the findings by Rosalind’s institutional review board that the program lacked scientific validity and demonstrable efficacy, the patients argued the program’s halt put their lives at risk.

After a preliminary hearing fared poorly for Rosalind, the school pursued a settlement with the former patients. The parties reached a deal where the university paid $2.5 million into a trust for the patients to resume the study with an additional $1 million to be paid if the plaintiffs were successfully able to get it started again, and $500,000 “to compensate the plaintiffs for pain and suffering.”

Rosalind sought coverage from two insurers: Lexington, which had issued primary and excess healthcare liability policies to the university, and Landmark, under a directors and officers liability policy.

Lexington paid for counsel, albeit with a reservation of its rights, and refused to contribute to the settlement. The deal represented a disgorgement of funds and not “damages” or a “loss” under the policies, Lexington argued. It also took the position that the underlying suit was not medical in nature and therefore was not within the ambit of Lexington’s policies; the former patients were really challenging an administrative decision to halt the program, the insurer said.

Landmark, which the parties agreed could only be on the hook for indemnification, also declined to chip in for the settlement. Landmark took an opposite stance as to the medical nature of the underlying complaint, arguing that the allegations involved a failure to render medical services and therefore fell under a medical malpractice exclusion in its policy.

Rosalind sued. In a somewhat mixed ruling for the insured, the Illinois Court of Appeals affirmed that the complaint fell under the professional services acts coverage of Lexington’s policy and that Lexington failed to timely object to the settlement. However, the court also determined that Landmark’s policy exclusion for medical malpractice precluded indemnification under the D&O policy.

The panel first rejected both insurers’ contention that the settlement constituted disgorgement. The vaccine program was funded by a donation from a deceased doctor and earmarked for cancer research generally, the court said, not the specific research program at issue. The remaining funds are still being held for that purpose, the court added, as Rosalind paid the former patients from general operating funds.

“[T]he underlying complaint also sought damages for breach of duties, fraud, and misrepresentation, which cannot be framed as disgorgement or a turnover of fund. The settlement agreement disposed of all of the underlying plaintiffs’ claims, including the nondisgorgement claim. Therefore, it is apparent that the settlement did not represent a disgorgement,” the panel wrote.

Did the former plaintiffs allege acts of a medical nature? Yes, the panel concluded, bringing the suit within the covered acts of professional services under the Lexington policy.

The preliminary statement of the complaint “alleges that Rosalind violated a cardinal principle of the medical profession” and “failed to ‘comport with their professional responsibilities as articulated in the Code of Medical Ethics’ by discontinuing care,” the court noted. The genesis of the former patients’ claims was the decision to shut down the vaccine program based on a lack of demonstrable efficacy of treatment, among other reasons.

Such decision-making constitutes “medical functions that require judgment aimed at protecting patients,” the panel explained. “Thus, Rosalind’s exercise of judgment in this regard constitutes professional service.”

While the court’s rejection of Lexington’s wrongful administrative acts argument meant one victory for the insured, it also brought the complaint under the medical malpractice exclusion in Landmark’s policy, negating indemnification under that policy for Rosalind.

Finally, the panel held that Lexington waived an argument that it failed to consent to the underlying settlement and therefore should not have to pay for it. Lexington was notified of the deal and its terms, the court said, and after it learned that settlement negotiations were ongoing, “had multiple opportunities to raise the issue of consent to settle or a voluntary payment defense, but it declined to do so until after Rosalind had executed the final settlement agreement.”

The insurer even sent a reservation of rights letter during the settlement negotiations and never referenced the pending deal. “Under such circumstances, we agree with the trial court that it would be inequitable to allow Lexington to raise the voluntary payment defense now,” the court concluded.

To read the order in Rosalind Franklin University of Medicine and Science v. Lexington Ins. Co., click here.

Tenth Circuit: Even If Insured Waited Too Long In Giving Notice, Insurer Suffered No Prejudice

Why it matters
Even though an underground salt mine waited too long to notify its insurer about water intrusion and resulting damage, the Tenth Circuit Court of Appeals said that coverage might still be available. Such a delay would only relieve the insurer of coverage if substantial prejudice occurred as a result, the federal appellate panel ruled. However, Lexington Insurance Company was unable to document how it would have handled the investigation or remediation process any differently or altered its underwriting process if the salt mine had given timely notice. The court reversed summary judgment in Lexington’s favor and remanded the case for a coverage determination.

Detailed Discussion
In January 2008, employees at an underground salt mine in Kansas noticed an inflow of water. Fearing dissolution of the salt or structural issues, Lyons Salt Company tried to figure out the source of the problem and determine a solution.

In April 2010, Lyons attributed the water flow to an improperly sealed oil well and characterized the mine’s future as “dire.” Lyons then notified insurer Lexington Insurance Company in July 2010 of the water problems.

Lexington discovered that in the preceding two years, Lyons had already spent more than $2.5 million to try to find and fix the problem; the total proof of loss was for $7.5 million, which included remediation measures taken by Lyons prior to notifying Lexington of the water intrusion.

Arguing that Lyons had sat on its claim, Lexington declined to pay. A federal district court granted summary judgment in the insurer’s favor when the salt mine sought a declaratory judgment to recognize coverage for the damage and related expenses.

But even assuming that the policyholder waited too long, Lexington failed to establish substantial prejudice, the Tenth Circuit concluded, reversing the lower court.

Under Kansas law, an insurer can show prejudice by presenting evidence that its ability to investigate a claim has been lost, by demonstrating that “it would have handled some aspect of the investigation, discovery or defense differently and that with this change, [the insurer] likely could have either defeated the underlying claims or settled the underlying claims for a lower sum than what the insureds settled.”

Lexington proffered three areas of prejudice: it lost the opportunity to independently investigate the water inflow; it lost the opportunity to provide input on how to resolve the water inflow problem; and it suffered underwriting prejudice.

The federal appellate panel shot down all three arguments. The insurer conducted its own independent investigation after it learned of the water problems, the court noted, and a contention that witnesses’ memories are “not as fresh” did not explain how the investigation had (possibly) been impeded.

At a deposition, Lexington’s own corporate representative responded to the question of whether the insurer’s investigation was hampered with “How could I know?” This rhetorical question summarized the insurer’s position, the court said.

As for prejudice in the remediation of the water problems, Lexington failed to “present evidence on how [its] input would have affected the remedial efforts,” the panel wrote. And the insurer provided no evidence that it would have done anything differently – like cancellation, non-renewal, or amendment of Lyons’ policies – had the salt mine provided timely notice of the inflow.

To read the decision in B.S.C. Holding, Inc. v. Lexington Ins. Co., click here.

Insured Not Required to Exhaust All Remedies Against Perpetrators of Fraud, Court Rules

Why it matters
Which party—the insured or the insurer—bears the loss caused by the inevitable delays that occur when a potentially liable third party does not accept responsibility for a loss suffered by the insured and covered by its policy, as well as the costs and risks of pursuing such claims? According to a new opinion from the Texas Court of Appeals, the policy puts the burden on the insurer. Lloyd’s of London declined to pay for a $16 million theft, arguing that the insured was required to exhaust all possible remedies against the thief before turning to its policy. But combined with a two-year limit for insureds to bring suit when a claim has been denied, the court said the insured should be paid now with the insurer bearing the loss until the third parties (possibly) pay up.

Detailed Discussion
Cardtronics owns and operates ATMs. Pursuant to a series of contracts, Cardtronics leased money from Bank of America, which was transported by Mount Vernon Money Center, an armored car company.

Mount Vernon’s president had other ideas, however, and stole millions of dollars from Cardtronics and other clients. When the theft – estimated to be around $50 million, $16 million of which came from Cardtronics – was discovered in 2010, Cardtronics notified its insurer, Lloyd’s of London.

Seeking recovery of its $16 million, Cardtronics requested payment from Lloyd’s. The policy required that the insurer accept or reject the claim within 15 days or extend the deadline for additional time to reach a decision. Lloyd’s repeatedly extended the deadline without rejecting Cardtronics’ claim for more than one year before finally refusing to pay.

Although the policy provided coverage for contingent cash in transit as well as losses resulting from theft, the insurer pointed to a provision regarding armored motor vehicle companies. Subparagraph E.4.A. provided that Lloyd’s would only pay for the amount of loss of contingent cash in transit that Cardtronics “cannot recover” under its agreement with an armored motor vehicle company or under any insurance carried either by that company or on behalf of its customers.

To comply with a two-year deadline in the policy, Cardtronics filed suit against Lloyd’s in Texas state court. The insured argued that it could not recover from Mount Vernon (which had filed for bankruptcy) or its insurers before the deadline lapsed, and so it was impossible for Cardtronics to exhaust its remedies.

Lloyd’s response: The applicable policy provision was contingent in nature and therefore it was not contractually responsible to pay anything until all possible remedies had been exhausted. The appellate court disagreed.

Although the insurer argued that “the Cardtronics policy is explicitly ‘contingent’ on an inability to recover from other sources,” the court said that “the policy does not contain such an express requirement.”

“Further, all insurance is contingent, explicitly or implicitly, on the insured’s experience of an actual loss that cannot be recovered immediately. If Cardtronics had recovered the stolen money and incurred no other losses before filing a proof of claim, then Cardtronics would not be entitled to a recovery from [Lloyd’s],” the court wrote. “But those are not the facts before us, and there is nothing in the policy language that requires Cardtronics to exhaust every possibility of recovery to establish that it ‘cannot recover’ under its contract with Mount Vernon or through any insurance policies purchased by Mount Vernon.”

In fact, the policy only required Cardtronics to bring one lawsuit – a case against the insurer within two years of discovery of the loss. Lloyd’s argument that policy coverage was not triggered until the amount of loss was conclusively determined was unreasonable, the panel wrote.

“[B]ecause the policy is silent as to a deadline for when Cardtronics must demonstrate what it ‘cannot recover’ before payment from [Lloyd’s] is triggered, the ‘conclusive determination’ language urged by [Lloyd’s] interpretation is unduly restrictive and too stringent a test,” the court said.

Cardtronics clearly suffered a compensable loss, the panel said, and the policy required the insured to pursue its claim even with uncertainty regarding its amount. The insured could not harmonize the exhaustion requirement with the two-year deadline for filing suit, the court determined, adding that Lloyd’s retained its subrogation rights and could pursue any claims upon Cardtronics’ later receipt of funds from third parties.

“[W]e hold that ‘cannot recover’ applies at the time of the proof of loss, which gives meaning to all provisions of the policy and therefore is not unreasonable,” the panel said. “Contracts should be interpreted to avoid rendering a provision meaningless, such as the deadlines imposed by the policy. It is therefore reasonable to interpret subparagraph E.4.A’s ‘cannot recover’ to mean ‘cannot recover at the time the insured submits its proof of loss within 120 days of when the insured learns of the loss.’”

To read the decision in Certain Underwriters at Lloyd’s of London v. Cardtronics, click here.