It has been nearly three months since Superstorm Sandy battered the East Coast of the United States. With several hundred thousand residents still without homes and many businesses still operating out of temporary facilities, it is too early to tell precisely what insurance coverage issues will arise, what positions insurers will take, and where the battle lines will be drawn in the inevitable coverage litigation that will make its way through the courts of New York and New Jersey over the next several years. But this is not the first time an enormous wind and rain storm has combined with storm surges to cause catastrophic losses across an entire region of the country. Seven years ago, Hurricane Katrina made landfall along the central Gulf Coast, causing widespread devastation across parts of Louisiana, Mississippi, and Alabama. Like Superstorm Sandy, damage from Hurricane Katrina was caused by high winds, heavy rainfall, and storm surges, often in sequence.

Hurricane Katrina resulted in several years of insurance coverage litigation, setting the stage for what we can expect to follow from Superstorm Sandy. Recognizing that what is past is prologue, this article reviews key procedural and substantive issues that arose out of Hurricane Katrina. Reviewing this litigation history with the benefit of hindsight helps to better understand the road ahead as policyholders with Sandy-related losses begin the difficult task of obtaining the full benefit of the insurance coverage they purchased.

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Ninth Circuit Backpedals on Scope of Insurer’s Duty to Settle

By Nancy Harris

In October, following an earlier pro-policyholder decision on an insurer’s duty to settle, the Ninth Circuit abruptly reversed course by releasing an amended ruling in Du v. Allstate Ins. Co., 697 F.3d 753 (9th Cir. 2012). Previously, in June, a Ninth Circuit panel held that under California law an insurer has an affirmative duty to effectuate settlement where liability is reasonably clear, even in the absence of a settlement demand. Du v. Allstate Ins. Co., 681 F.3d 1118 (9th Cir. 2012). The Court also originally ruled in Du than an insurer’s genuine dispute with its insured about the availability of coverage for a settlement does not immunize the insurer for liability for failing to effectuate a reasonable settlement. The duty to settle is a fundamental obligation for insurance companies and failing to fulfill that obligation can provide a basis for bad faith claims under California law. See Celia M. Jackson, The Settlement Dilemma: When a Policyholder and Insurer Disagree on Settlement (Policyholder Observer, June 13, 2012). The initial pronouncement in Du was a significant enunciation and extension of an insurer’s duty to settle. The Du ruling was heralded by the plaintiffs’ bar and lambasted by insurance defense attorneys. But then, on October 5, the Court issued an amended ruling that retained its holding but removed its clarification of California law.

The plaintiff in Du was one of four injured parties in an automobile accident caused by Joon Hak Kim, the insured. Kim’s insurer, Allstate subsidiary Deerbrook Insurance Company, rejected a pre-filing $300,000 policy limit demand for all four plaintiffs and asserted that it did not have sufficient information to settle all of the claims. Deerbrook countered with a $100,000 offer to settle with Du alone, which plaintiffs refused and then filed their lawsuit. After Du received a judgment of just over $1.4 million against Kim, Kim assigned his bad faith claim against Deerbrook to Du. Du contended that the case would have been settled within policy limits had Deerbrook initiated earlier settlement negotiations (or presumably responded favorably to plaintiffs’ demand) and on that ground asserted the insurer acted in bad faith.

In its October amended decision, the Court avoided deciding the issue of whether the duty to “effectuate” a settlement includes an affirmative duty to make a settlement even before a demand is made. It found that the insurer had initiated settlement discussions as soon as it had corroborating medical evidence of the extent of the injuries and that it need not reach the issue of whether a duty exists because the insurer had made timely settlement offers.

Although the Court excised from the amended opinion its discussion and conclusion that California law requires that an insurer affirmatively initiate a settlement within policy limits after liability has become reasonably clear, the amended decision still references case law that it asserts extends “the duty to settle beyond mere acceptance of a reasonable settlement demand.” Given the discussion that remains and the uniqueness of the Du facts, the Ninth Circuit’s amendment of its opinion should not be interpreted as a rejection of a duty to proactively initiate and effectuate settlement but, more likely, a decision to defer the issue to another day and a more amenable factual scenario.

Federal Judge Bars Insurer From Cancelling Coverage After Broker Fails to Remit Premium Payments

U.S. District Judge Harold Baer, Jr., ruled that Ace American Insurance Co. was not entitled to cancel a liability policy issued to Maclaren Europe, Inc., an English manufacturer of baby strollers, when a broker failed to remit premium payments from Maclaren to Ace. Maclaren Europe Ltd. v. Ace American Ins. Co., No. 11 Civ. 4688 (HB), (S.D.N.Y. Nov. 5, 2012). The court held that the broker was Ace’s agent “for the limited purpose of receiving on Ace’s behalf the payment of any premium which was due[.]” Judge Baer’s decision turned on choice of law:  Under English law, which Ace sought to apply, the broker would have been the policyholder’s agent, whereas under New York law, once the insurer delivers the policy to the broker, the broker is “held to be an agent of the insurer for the purpose of the payment of the premium on that policy.” In his choice of law ruling, Judge Baer noted that the “center of gravity” for the coverage claim was “not readily determined,” but observed that the first named insured was a Connecticut affiliate of Maclaren, the insured’s domiciles were in England and Hong Kong, the policy was placed through New York brokers, and payment of premiums was to a New York account. He concluded that the interests at stake were “less about construction of the policy than … ‘the authority of the New York-based brokers that procured the polic[y],’” tilting the balance of interests in favor of applying New York law.

New York Court of Appeals: Insured Who Failed to Read Policy May Still Have Valid Claim Against Broker for Failing to Secure Requested Coverage

New York’s highest court ruled on November 19, 2012, that an insured that directed its broker to secure a policy with coverage for employee injury claims, but did not read the policy wording once issued or complain about the lack of such coverage, could nevertheless maintain a suit against its broker for failing to secure the coverage requested after suffering an employee injury loss. American Bldg. Supply Corp. v. Petrocelli Group, Inc., No. 188 (N.Y. Ct. App. Nov. 19, 2012). The broker maintained that the insured’s claim was barred by its receipt of the policy without complaint. According to the majority, however, “[t]he failure to read the policy, at worst, may give rise to a defense of comparative negligence but should not bar, altogether, an action against the broker.” 

Second Circuit Holds That Non-Cumulation Clause Overcomes Pro Rata Allocation Rule in Long-Tail Claims

On December 19, 2012, the U.S. Court of Appeals for the Second Circuit determined in Olin Corp. v. American Home Assurance Co., No. 11-4055, that the “non-cumulation” clause in American Home and Lloyd’s excess policies allowed the insured to telescope a long-tail claim for environmental property damage into a single year of coverage, overcoming the pro rata allocation method that has become the default rule under New York law. The case involved a $102 million cleanup of perchlorate released from Olin’s plant in Morgan Hills, California, resulting in property damage that continued over a 31-year period. New York courts, including an earlier panel in Olin, have held that, in the absence of contrary contract language, such a continuing loss must be allocated pro rata to all policies in effect during the period of property damage. Consol. Edison Co. of N.Y. v. Allstate Ins. Co., 778 N.E.2d 687, 695 (N.Y. 2002); Olin Corp. v. Ins. Co. of. N. Am., 221 F.3d 307, 324-27 (2d. Cir. 2000). American Home and Lloyd’s argued that because Olin’s loss at the Morgan Hills site must be spread over 31 years of coverage, the loss was insufficient to reach the attachment point of their excess policies. However, Condition C of their policies (the “non-cumulation” clause) provided, among other things, that “in the event that personal injury or property damage arising out of an occurrence covered hereunder is continuing at the time of termination of this Policy, Underwriters will continue to protect the Assured for Liability in respect of such personal injury or property damage without payment of additional premium.” The Court concluded that this language overcame the default rule and provided continuing coverage outside the policy term. The ruling provides an important coverage tool under New York law for policyholders, as such non-cumulation provisions have been fairly common in umbrella and excess liability policies.

Oregon Federal Court Confirms Duty to Defend Notwithstanding Application of Deductible and Claims Servicing Agreement Clause

Confirming an earlier ruling upon reconsideration, the U.S. District Court for the District of Oregon held that the application of a deductible endorsement in a liability policy did not relieve an insurer from its obligation to provide a defense before the deductible was exhausted. Century Indemnity Co. v. The Marine Group, LLC, No. 3:08-cv-01375-AC (D. Ore. Dec. 3, 2012). The court based its ruling on the distinction between a deductible and a self-insured retention. With a self-insured retention, the policyholder retains liability, including the obligation to defend claims, until the retention is exhausted. With a deductible, the policyholder is obligated to indemnify the insurer for losses within the deductible, but the insurer remains obligated to provide a defense. The court found that the policy’s deductible endorsement provided “a true deductible,” and therefore, a defense was owed. The court further found that a “claims servicing agreement clause” that purported to override the deductible provision did not apply because the parties had not entered into a separate claims servicing agreement.

Insurer Has Duty to Defend and Indemnify Hotel for Legionnaires' Disease Death, Eleventh Circuit Holds

On October 25, 2012, the Eleventh Circuit affirmed a district court ruling that a hotel’s insurer owed the duty to defend and indemnify the hotel in a wrongful death suit brought by a hotel guest who contracted Legionnaires' Disease. Westport Ins. Corp. v. VN Hotel Group, LLC, 6:10-cv-0222 (11th Cir. Oct. 25, 2012). VH Hotel Group, owner of a Quality Suites hotel, sought coverage for a wrongful death suit after two of its guests contracted Legionnaires' Disease from the hotel’s outdoor spa. The hotel’s insurer, Westport Insurance Corporation, denied coverage and brought a declaratory relief action seeking a determination that coverage was barred based on two exclusions: a standard pollution exclusion and a “fungi or bacteria” exclusion. The fungi or bacteria exclusion excluded coverage for bodily injury caused by the exposure to any “‘fungi’ or bacteria on or within a building or structure."

Applying Florida law, the Court of Appeals affirmed the district court’s holdings that Westport had both a duty to defend and a duty to indemnify the hotel. It agreed with the district court’s analysis that Legionnaires' Disease did not fall under the definition of pollution, and since both parties agreed that the disease is bacterial, extending the pollution exclusion to cover bacterial diseases would render the fungi or bacteria exclusion meaningless. It also affirmed the district court’s holding that the fungi or bacteria exclusion did not bar coverage because the legionella bacteria did not occur on or within a building or structure. Construing the exclusion narrowly and against the insurer, the Court rejected the insurer’s contention that the definition of “structure” was broad enough to encompass an outdoor spa.

Eleventh Circuit Rejects Insurer’s Argument that Late Notice of Initial Complaint Bars Coverage for New Claims in Amended Complaint

On October 22, 2012, the Eleventh Circuit rejected an insurer’s aggressive argument that coverage was barred for new claims asserted in an amended complaint becasue the policyholder gave belated notice after the original complaint was filed more than two years before. State Farm Fire & Cas. Co. v. LeBlanc, et al., 7:09-cv-00076 (11th Cir. Oct. 22, 2012). In the original complaint, a plaintiff alleged ten causes of action, including unfair competition and deceptive trade practices, against the policyholders. The policyholders waited five months before notifying State Farm Fire & Casualty Company (“State Farm”) of the complaint because they did not think they had coverage for such claims. More than two years later, the plaintiff filed an amended complaint that added new claims. The policyholders immediately notified State Farm.

Applying Georgia law, the Eleventh Circuit held that policy language requiring that a policyholder “must see to it” that the insurer receives “prompt written notice” of a claim constitutes a condition precedent to coverage. The Court of Appeals held that the policyholders’ five-month delay was unreasonable and did not find their professed lack of knowledge of coverage under the policy a valid excuse. Because Georgia law does not require that late notice prejudice the insurer, the Eleventh Circuit affirmed the district court’s ruling that the policyholders had waived coverage for the initial complaint.

State Farm also argued that the new claims in the amended complaint similarly were barred as untimely due solely to the late notice of the original complaint, notwithstanding the policyholders’ prompt notice of the amended complaint. Because Georgia law does not require a policyholder to anticipate all future claims when providing notice, the Eleventh Circuit rejected State Farm’s contention that mere late notice of the original complaint bars coverage for new claims in the amended complaint.

Virginia Supreme Court Holds Exclusions Bar Coverage for Chinese Drywall Claim

An all risk homeowners’ insurance policy does not provide coverage for damage caused by defective drywall manufactured in China, according to a November 1 decision by the Virginia Supreme Court. TravCo Ins. Co. v. Ward, No. 120347 (Va. Nov. 1, 2012). A homeowner sought coverage from his homeowners’ insurer, TravCo Insurance Company (“TravCo”), for damage caused when Chinese drywall installed in his new home emitted sulfide gasses which created noxious odors and damaged various systems in his home. TravCo denied the claim, relying on various exclusions, including a pollution exclusion, which applied to loss caused by the discharge of pollutants, defined to include any gaseous contaminant or irritant.

Answering a certified question from the Fourth Circuit, Virginia’s highest court held that four separate exclusions—for latent defects, inadequate or defective materials, rust or corrosion, or pollution—unambiguously excluded coverage for such damage. Under the terms of the pollution exclusion, the Court held that sulfuric gas was both a contaminant, because it was not supposed to be in the home, and an irritant, because it caused harm to people living there. It also rejected the policyholder’s argument that the process by which the gasses were emitted did not constitute a discharge of pollution. This is the first decision of a state supreme court on the applicability of exclusions to Chinese drywall claims.