In This Issue:

• Court’s Decision Prompts Policyholders to Seek Defense Quickly or Risk Awaiting Conclusion of Coverage Action to See Reimbursement
• Policyholders Beware: New York’s Harsh Late Notice Rule Still Alive Despite 2009 Amendment
• Bank’s Reimbursement to Client Required by Law and Therefore Not “Voluntary Payment”
• Insured v. Insured Exclusion Ambiguous, California Court Finds: Bank Ds and Os Entitled to Coverage for FDIC Suit

Court’s Decision Prompts Policyholders to Seek Defense Quickly or Risk Awaiting Conclusion of Coverage Action to See Reimbursement

Why it matters

A policyholder who does not act promptly to seek advancement of defense fees and costs from its carrier could face a double whammy if the carrier denies coverage: not only will the policyholder be required to then fund the defense of the underlying action, but it may not be able to seek reimbursement of past fees and costs until a subsequent coverage action is finally adjudicated.

Detailed Discussion

QBE Americas was accused of participation in kickback schemes involving forced-place insurance for mortgage borrowers, faced roughly 40 lawsuits across the country, and was the subject of at least one government investigation.

The company sought coverage for, inter alia, defense costs incurred in pending litigation where AIG and Darwin refused to advance them. The AIG policies stated that “[AIG] shall have the right, but not the duty, to assume the defense of any Claim made against the Insured.” The Darwin policies, in contrast, provided that the insurer “shall have the right and duty to defend any Claim to which the Insuring Agreements apply.”

That seemingly slight difference meant that QBE could recover all of its go-forward defense fees and costs from Darwin now, but any recovery from AIG had to await the outcome of the coverage litigation.

“The AIG policies expressly disclaim the duty to defend,” the court said. “[A]t most, before the merits of the coverage dispute is adjudicated, QBE could only compel AIG to pay for its defense costs for the portion of its pending litigation attributable to covered claims.”

But “Darwin, in contrast, has a duty to defend,” Judge Kornreich said, based on the “right and duty” language of its policy. “Hence, Darwin . . . is obligated to advance all of QBE’s litigation costs so long as each lawsuit presents the possibility that any of the QBE entities or any of the claims asserted might be covered.”

Significantly, the court further held that QBE could not recover at this time defense fees and costs already incurred either in pending litigation or in litigation that had settled, notwithstanding the duty-to-defend language. The court ruled that if QBE had wanted defense costs advanced in those lawsuits (some of which had been filed three years prior), then it should have sought them while the underlying litigation was pending. Because it waited, it could not recoup the amounts spent until the merits of the coverage action were finally adjudicated.

To read the opinion in QBE Americas, Inc. v. ACE American Insurance Co., click here.

Policyholders Beware: New York’s Harsh Late Notice Rule Still Alive Despite 2009 Amendment

Why it matters

Choice-of-law provisions can make a big difference in the outcome of a coverage dispute. The Second Circuit’s ruling against the City of San Diego has again demonstrated why. The City’s policy contained a New York choice-of-law provision, and the City notified the carrier of a claim 58 days after receiving it. The carrier denied coverage for late notice under New York’s stringent common law, which permits denial without a showing of prejudice. And the Second Circuit affirmed the denial, holding that the New York Legislature’s statutory amendment requiring the carrier to show prejudice did not apply because the policy had not been “issued” in New York. Accordingly, a policyholder with a New York choice of law provision in its policy could still be subject to New York’s late notice laws, which potentially permit carriers to deny coverage if notice is received more than a month after a claim has been made.

Detailed Discussion

The City of San Diego gave notice of a claim to its carrier 58 days after it received it. The U.S. Court of Appeals, Second Circuit, upheld the carrier's late notice denial, finding that (1) a New York law requiring the carrier to prove prejudice did not apply and (2) 58 days was not “as soon as practicable” as a matter of law.

The City purchased a pollution and remediation legal liability insurance policy from Indian Harbor Insurance Company in 2009. The policy contained a New York choice of law provision and required the City to notify Indian Harbor “as soon as practicable” of any liability claims.

Just before the policy was issued, the New York Legislature amended Section 3420(a)(5) of the state’s Insurance Law. The provision barred liability insurers from denying claims by reason of late notice unless the insurer suffered prejudice for all policies issued or delivered in New York after Jan. 17, 2009. Prior to the change, New York common law did not require the insurer to demonstrate prejudice before denying coverage based on a policy’s timely notice provision.

The City sought coverage for three pollution-related claims, including a claim filed by Centex Homes. Indian Harbor denied coverage based on what it characterized as late notice by the City, pointing to the 58 days it took to notify the insurer about the Centex claim.

In a declaratory judgment action, the City argued that Indian Harbor failed to assert it suffered any prejudice as required by Section 3420(a)(5), adding that the notification provided was not late as a matter of law. A federal district court judge disagreed and the Second Circuit affirmed summary judgment for the insurer.

The Second Circuit held Section 3420(a)(5) did not apply because the policy was not “issued” in New York as required under the provision. The City argued that the policy was issued in the state because it was signed by Indian Harbor’s president, Dennis Kane, whose office was located in New York. The Second Circuit rejected the City’s argument, holding that Mr. Kane’s electronic signature was actually affixed in the carrier’s Pennsylvania office, which is where the policy had been issued.

“But Kane’s signature was a pre-existing electronic signature, and it was affixed to the Policy in Exton, Pennsylvania, without his being present there,” the court wrote. “The Policy was created and mailed from the Pennsylvania office and all transmittal paperwork bore the Pennsylvania office’s letterhead. The City has proffered no evidence to show that the Policy was issued, or even signed, in New York.”

The Second Circuit also rejected the City’s argument that the amendment to Section 3420(a)(5) codified public policy and changed New York common law, which did not require the carrier to demonstrate prejudice from the late notice.

Finally, the panel held that the 58 days that elapsed before the City informed the insurer about the Centex claim was unreasonable as a matter of law. “Under New York law, delays of one or two months are routinely held unreasonable,” the court wrote, affirming summary judgment for the insurer. “The City has adduced no evidence to demonstrate that its 58-day delay was unreasonable,” the unanimous panel added, and the “purpose of these notification requirements . . . is to permit the insurance company to investigate promptly.”

To read the order in Indian Harbor Insurance Company v. City of San Diego, click here.

Bank’s Reimbursement to Client Required by Law and Therefore Not “Voluntary Payment”

Why it matters

Where the insured’s liability was clear and state law required the insured to make its client whole, the carrier could not later complain that the insured’s reimbursement to its client without the carrier’s written consent constituted an uncovered voluntary payment.

Policyholders should read this case as an exception to the general rule: Always involve your carrier at the earliest opportunity, particularly when considering paying money to resolve a claim. Otherwise, you can be sure that the carrier will contest coverage.

Detailed Discussion

On August 31, 2012, a wire transfer of $2,158,600 was made from a client’s account at First Commonwealth Bank in Pennsylvania to an account in Krasnodar, Russia. One problem: the client didn’t authorize the transfer, but was the victim of a malware attack that allowed an unknown third party to access the client’s computer systems.

Two more unauthorized wire transfers followed on September 4, with $76,520 wired to an account in Upper Darby, Pennsylvania, and a third transfer of $1,350,000 to a bank in Belarus. The bank didn’t realize the transfers were fraudulent until the afternoon of September 4.

The bank managed to recover only the amount transferred to the Pennsylvania account; the Belarus and Russia transfers were gone, leaving the client with a $3,508,600 loss. The client immediately demanded a refund or credit for the amounts, and the bank obliged on September 8, using its own funds.

First Commonwealth then sought its own recovery from insurer St. Paul Mercury Insurance Company. The insurer refused to provide coverage and the bank filed a declaratory judgment action.

The policy included a voluntary payments provision that prohibited the bank voluntarily making a payment without the carrier’s written consent. The insurer argued the bank breached the terms of this provision and forfeited coverage. The bank, in contrast, argued it was obligated by law to refund the monies and, further, that it had no valid defense to their client’s demands. Thus the refund had not been a “voluntary payment.” The court agreed.

Looking to Black’s Law Dictionary for a definition of "voluntary" as “[u]nconstrained by interference; not impelled by outside influence,” Judge Kelly said she could not find that the bank’s reimbursement was voluntary. “It is difficult for the Court to find that the mandate of 13 Pa. C.S.A. Section 4A204 [the law requiring the refund] is not an outside influence that interfered with the restrictions imposed upon Plaintiffs under the Policy,” she wrote.

The court denied St. Paul’s motion to dismiss the bank’s suit.

Insured v. Insured Exclusion Ambiguous, California Court Finds: Bank Ds and Os Entitled to Coverage for FDIC Suit

Why it matters

In the latest decision to weigh in on the scope of the Insured v. Insured exclusion, a California court has held that it is ambiguous as applied to suits brought by the FDIC, and therefore does not preclude coverage for the directors and officers of a failed bank.

This is an encouraging decision in light of other courts that have found that the exclusion did apply. In fact, the court here noted the inconsistent results nationwide and held that those decisions put carriers on notice that the exclusion was, in fact, ambiguous, and it should have been made more clear in order to apply to an action brought by the FDIC. Compare (finding exclusion did not apply) with (Insured v. Insured exclusion applies).

Detailed discussion

In November 2009 the Office of the Comptroller of the Currency closed the Pacific Coast National Bank and the FDIC was appointed as receiver. Three years later the FDIC sued six former directors and officers of the bank for negligence, gross negligence, and breaches of fiduciary duty, alleging they approved various loans that resulted in millions of dollars of losses to the bank.

St. Paul Mercury Insurance, the bank’s directors and officers liability insurer, refused to defend the suit, relying upon the policy’s Insured v. Insured exclusion, which, in this case, precluded coverage for claims “brought or maintained by or on behalf of any Insured or Company [including the Bank] in any capacity. . . .” (Emphasis added.) The exclusion also contained a giveback of coverage for any claim that is a “derivative action brought or maintained on behalf of the Company by one or more persons who are not Directors or Officers and who bring and maintain such Claim without the solicitation, assistance or active participation of any Director or Officer.”

St. Paul filed a declaratory judgment action seeking an order that it was not required to defend the FDIC’s lawsuit and both parties filed summary judgment motions.

Finding the exclusion ambiguous, U.S. District Court Judge Andrew J. Guilford granted the insureds’ summary judgment.

Courts considering the Insured v. Insured exclusion in coverage disputes over FDIC lawsuits on behalf of failed banks have reached varying conclusions, the court noted, lending weight to the conclusion that the phrase “on behalf of” is ambiguous when applied to the FDIC. “There can be little doubt that repeated disputes over the IvI [Insured v. Insured] Exclusion have placed insurers on notice that it is ambiguous,” the judge wrote.

St. Paul “had the opportunity to make clear in the Policy that the IvI exclusion applied to [the FDIC], and it could have done so with a simple statement,” the court said. “Indeed, [St. Paul] provides an optional regulatory exclusion – not included in the policy here – that explicitly names the FDIC. It could have included similarly clear language in the IvI exclusion. Having failed to meet its burden ‘to phrase exceptions and exclusions in clear and unmistakable language,’ [St. Paul] cannot now benefit from the ambiguity.”

While the FDIC “steps into the shoes” of the bank when it takes over as receiver, the agency plays a multitude of roles and the insurer should have been more explicit in the policy, Judge Guilford wrote.

Even if the IvI exclusion did apply to the FDIC, the court added that the Shareholder Exception contained in the provision would bring the lawsuit back within the scope of policy coverage. The FDIC also represents the interests of the bank’s shareholders, the judge said, because under the Financial Institutions Reform, Recovery, and Enforcement Act, the FDIC as receiver succeeds to the rights not only of the failed bank, but also “of any stockholder, member, [or] accountholder . . . of such institution.”

“The Policy at issue here provides coverage for claims by shareholders, even for derivative actions brought by the shareholders on behalf of the Bank,” Judge Guilford said.

Although the complaint was not filed as a derivative action, the court asked, “On whose behalf does [the FDIC] bring these claims? The Shareholder Exception ‘evidences an intent to place on insurer the risk for actions against the D&Os based upon allegations of mismanagement, waste, fraud, or abuse of the failed institution. The Policy should therefore cover these claims if [the FDIC] pursues them under its authority to recover losses on behalf of shareholders. This is true even if the procedure by which [the FDIC] asserts the claims differs from the derivative action available to shareholders.”

The court also rejected St. Paul’s contention that an Unrepaid Loan Carve-Out in the policy barred coverage. Just because the FDIC complaint requested damages in the amount of certain unrepaid loans, the exclusion did not “unambiguously apply to cases where tortious conduct results in damages that might happen to be in the amount of unrepaid loans,” the judge wrote.

To read the order in St. Paul Mercury Insurance Co. v. Hahn, click here.