In This Issue:

• California Court: Rejected Demand Within Policy Limits Not Necessary for Bad Faith Claim
• CERCLA Action a "Suit" for Purposes of CGL Policy, Texas Supreme Court Rules
• Question of Related Claims Survives Motion to Dismiss
• Court Orders Coverage as Some Allegations Fall Outside Policy Exclusion

California Court: Rejected Demand Within Policy Limits Not Necessary for Bad Faith Claim

Why it matters: Insurers must proceed with caution when they become aware that a settlement within policy limits is possible, because a failure to settle may constitute bad faith. And a rejected demand within the policy limits is not required to establish a bad faith failure to settle claim against an insurer, a California federal court judge recently concluded. The case involved a real estate company sued for rescission of a home sale. The parties engaged in settlement talks and the insured learned that it could make a deal for less than the limits of its policy with the insurer. However, the insurer made settlement offers below the amount requested by the underlying plaintiff and filed a declaratory action while the settlement negotiations were ongoing seeking to rescind the policy. The policyholder responded with a counterclaim for bad faith failure to settle. Ruling on the insurer's motion to dismiss, the court said a policyholder is not required to demonstrate that a demand was made within the policy limits in order to establish bad faith. Instead, an insured must simply allege some "circumstance demonstrating the insurer knew that settlement within policy limits could feasibly be negotiated," the judge wrote.

Detailed discussion: A married couple purchased a home from Willis Allen Real Estate. Not long after, a landslide caused a significant portion of their new backyard to slide into an adjacent canyon. The couple filed suit against multiple defendants, including Willis Allen, the real estate company, seeking rescission of the house purchase and recovery of home repair costs.

Willis Allen tendered defense of the suit to Aspen Specialty Insurance Company. Initially, the insurer agreed to defend and Willis Allen began settlement negotiations with the married couple. However, while the negotiations were still ongoing, Aspen filed a declaratory judgment action against Willis Allen seeking rescission of the policy, arguing that it had misrepresented material facts when it purchased the policy.

Willis Allen fought back, filing a counterclaim for breach of contract and bad faith failure to settle the underlying lawsuit by ignoring Willis Allen's liability exposure and refusing to give policy limits settlement authority.

Aspen moved to dismiss the counterclaim, arguing that the bad faith failure to settle the claim failed as a matter of law because Willis Allen did not allege that the married couple had made a policy limits demand or otherwise indicated they would settle within policy limits. According to Aspen, this meant it had no duty to settle and only a duty to negotiate, which it did by making settlement offers, albeit too low.

Willis Allen disagreed. Counsel kept the insurer abreast of its settlement efforts throughout the process, the policyholder told the court, and requested authority from Aspen to settle up to the policy limits. When the policyholder learned it could resolve the claims for "substantially less" than the policy limits, it informed Aspen. But the insurer refused to give policy limits settlement authority and made offers "well below" the amount requested by the married couple.

The lowball offers from Aspen prevented a settlement and drew out the negotiations, the insured said. When a settlement was ultimately reached, it completely exhausted the policy, thereby requiring Willis Allen to contribute a substantial amount of its own money.

Denying the motion to dismiss the counterclaim, U.S. District Court Judge Larry Alan Burns rejected the insurer's position that a policy limits demand was required for a claim of bad faith failure to settle.

"An insurer is obligated to act reasonably to protect their insureds from liability in excess of policy limits," the court said. "Thus 'under California law, an insurer has a duty to effectuate settlement where liability is reasonably clear, even in the absence of a settlement demand.'"

Two avenues exist for insurers to be liable for bad faith failure to pursue a settlement, the court explained: "[S]ome evidence either that the injured party has communicated to the insurer an interest in settlement, or [] some other circumstance demonstrating the insurer knew that settlement within policy limits could feasibly be negotiated," citing a Ninth Circuit Court of Appeals decision, Highlands Ins. Co. v. Continental, 64 F.3d 514 (1995).

Although Aspen contended that the injured party must express an interest in settlement to trigger an insurer's duty to pursue good faith settlement discussions, "Aspen is mistaken. All that's required is some circumstance showing that Aspen knew settlement within policy limits was feasible," Judge Burns wrote.

The counterclaim specifically alleged such a circumstance, claiming that the insurer was informed that Willis Allen likely could resolve the claim against it for substantially less than the policy limits. The counterclaim "also alleges that the [married couple] engaged in mediation in hopes of settling the case, Willis Allen's defense counsel warned Aspen of potential above policy limits damages, and defense counsel requested policy limits settlement authority, but Aspen refused."

"Accepting these factual allegations as true and construing them in the light most favorable to Willis Allen, the [counterclaim] plausibly alleges that Aspen 'refused in bad faith a reasonable opportunity to settle,' " the court said. "Thus, Willis Allen's allegations are sufficient to survive Aspen's motion to dismiss."

To read the order in Aspen Specialty Insurance Company v. Willis Allen Real Estate, click here.

CERCLA Action a "Suit" for Purposes of CGL Policy, Texas Supreme Court Rules

Why it matters: Answering a certified question from the Fifth Circuit Court of Appeals, the Texas Supreme Court determined that an enforcement proceeding under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) is a "suit" for purposes of a commercial general liability (CGL) policy, requiring insurers to provide a defense. McGinnes Industrial Maintenance Corporation (McGinnes) dumped pulp and paper mill waste sludge into disposal pits during the 1960s when it was insured under CGL policies from The Phoenix Insurance Company (Phoenix) and Travelers Indemnity Company (Travelers). In 2005, the Environmental Protection Agency (EPA) began an investigation and served a general notice letter to McGinnes in 2007 that it was a potentially responsible party under CERCLA. Although McGinnes turned to its insurers for help, they refused, arguing that the EPA's enforcement action was not a "suit" covered under the policy. The policyholder filed a declaratory judgment action and a federal court granted summary judgment to the insurers. McGinnes appealed and the Fifth Circuit asked the Texas Supreme Court for guidance. Emphasizing the unique nature of the EPA's enforcement proceedings ("in actuality … the suit itself, only conducted outside a courtroom"), the split court concluded the action was covered by the policies and the insurers had a duty to defend. With the policyholder-friendly decision, Texas joins the majority of courts that have considered the issue to find that CERCLA proceedings constitute a "suit" under a CGL policy.

Detailed discussion: During the 1960s and early 1970s, McGinnes removed waste from a paper mill and released it in three ponds adjacent to the San Jacinto River in Texas. McGinnes had purchased CGL policies from Phoenix and Travelers during this period.

The policies provided that the insurers "shall have the right and duty to defend any suit against [McGinnes] seeking damages on account of … property damage, even if any of the allegations of the suit are groundless, false or fraudulent, and may make such investigation and settlement of any claim or suit as it deems expedient." None of the policies defined the term "suit."

In 2005, the EPA began investigating McGinnes' alleged pollution of the river pursuant to CERCLA. In 2007 the EPA sent McGinnes a Potentially Responsible Party (PRP) letter contending that it had contributed to the hazardous waste contamination at the site. The EPA (1) demanded that McGinnes reimburse the agency for remediation costs, (2) ordered McGinnes to conduct a Time-Critical-Removal-Action to prevent further contamination, and (3) demanded that McGinnes fund a Remediation/Investigation/Feasibility Study.

McGinnes turned to the insurers for defense of the EPA's CERCLA action. But both insurers disclaimed a duty to defend, arguing that the policy's term "suit" was limited to traditional lawsuits in a court of law—not an administrative action. The policyholder filed a declaratory judgment action seeking a ruling that a defense was owed and payment for more than $2 million in attorney's fees it had already spent.

A federal district court judge granted summary judgment for the insurers and McGinnes appealed. The Fifth Circuit Court of Appeals certified the question of whether coverage existed to the Texas Supreme Court.

In a 5-4 decision, the majority sided with the policyholder.

"We agree with the Insurers that 'suit' commonly refers to a proceeding in court," the court said. "Although the word is sometimes defined more generally as 'the attempt to gain an end by legal process,' the more specific connotation is an attempt through process in court. But for three reasons we think 'suit' in the CGL policies at issue must also include CERCLA enforcement proceedings by the EPA."

The first reason: CERCLA was intended "to authorize the EPA to conduct on its own what otherwise would have amounted to pretrial proceedings, but without having to initiate a court action until the end of the process," the court explained. The PRP letters serve as pleadings while a unilateral administrative order resembles summary judgment, with "part of the judicial function [] ceded to the EPA by limiting a PRP's opportunity for review until the end of the process, and then limiting that review to an abuse of discretion by the EPA, based on its own record."

The EPA proceedings "are the suit itself, only conducted outside a courtroom," the court said. "CERCLA effectively redefined a 'suit' on cleanup claims to mean proceedings conducted by one of the parties, the EPA, followed by an enforcement action in court, if necessary. McGinnes's rights under its policies should not be emasculated by the enactment of a statute intended not to affect insurance, but to streamline the EPA's ability to clean up pollution."

This conclusion does not extend an obligation for insurers to provide a defense for every demand letter, the court clarified, as a simple demand letter threatening or prefacing a lawsuit "is nothing like a PRP letter or unilateral administrative order," which command compliance. Nor would the ruling affect administrative proceedings, the court added, again distinguishing EPA enforcement proceedings as "unusual: not only are they like judicial proceedings, they were judicial proceedings before CERCLA was enacted."

As a second reason for its holding, the majority also noted the well-settled law that cleanup costs under CERCLA are "damages" covered by the form CGL policies at issue. "To interpret the policies as covering the damages incurred as a result of pollution cleanup proceedings without giving the Insurers the right and duty to defend those proceedings creates perverse incentives and consequences for insurers and insureds alike," the court wrote.

Third, and finally, the court cited the weight of authority from other jurisdictions. The highest courts of Alabama, Colorado, Connecticut, Iowa, Kentucky, Massachusetts, Michigan, Minnesota, Nebraska, New Hampshire, North Carolina, Vermont, and Wisconsin have all reached a similar conclusion. Only 3 of the 16 high courts to consider the issue—California, Illinois, and Maine—have adopted the insurers' position and the most recent of those decisions was in 1998.

To the Fifth Circuit's question: "Whether the EPA's PRP letters and/or unilateral administrative order, issued pursuant to CERCLA, constitute a 'suit' within the meaning of the CGL policies, triggering the duty to defend," the majority answered "yes."

To read the opinion in McGinnes Industrial Maintenance Corporation v. The Phoenix Insurance Company, click here.

To read the dissent, click here.

Question of Related Claims Survives Motion to Dismiss

Why it matters: A California federal court denied an insurer's motion to dismiss that was asserting that it had no duty to defend an underlying lawsuit because it was related to a prior claim that was made but not reported during a prior policy period. A resident filed suit against a homeowner's association alleging various negligence and breach of fiduciary duty claims. The association sought defense from its insurer, who initially stepped up to the plate. However, the insurer then changed its mind, arguing that the resident had requested a meeting with the association board more than a year prior to filing the lawsuit. The insurer argued that this meeting constituted a "claim" under the policy, which was not reported during the required time period, and, therefore, it had no defense obligation. But the judge disagreed, holding that the court needed more information. Whether or not the resident's meeting with the association was a related claim "necessarily entails a factual inquiry, which is premature for the Court to conduct on a motion to dismiss," the court said.

Detailed discussion: Wendell Bonner owned a residential property in Rancho Tehama and was a member of the Rancho Tehama Association. In July 2012, Bonner requested a meeting with the Association's Board of Directors. After the meeting, Bonner expressed his satisfaction with the response of the Board to his concerns and indicated that he did not plan to file suit against the Association.

One year later, Bonner apparently changed his mind, filing a complaint against the Association in California state court in September 2013. Seeking damages for negligence and breach of fiduciary duty, Bonner claimed that the Association failed to enforce the Tehama Rancho Association Covenants, including allowing temporary outbuildings to be erected and permitting "noxious and offensive activities" to be carried on throughout the various lots.

Pursuant to a policy purchased from Federal Insurance Company for 2013-2014, the Association requested defense from the insurer. Although Federal initially advised that it would provide a defense, the insurer reversed its position just two months later. No coverage existed for the underlying action, Federal said, because the policyholder failed to timely report Bonner's claim.

The Association then filed suit against Federal seeking declaratory relief that Federal had an obligation to provide a defense and breached the contract between the parties.

Federal held fast to its position that Bonner's 2012 contact with the Association was a "Claim" under the 2012-2013 policy, which was in effect from March 1, 2012, through March 1, 2013, that the policyholder failed to timely report. The policy provided coverage for " 'Claims' first made during the 'policy period,' or any extended reporting period," with a "Claim" defined as any "written demand for monetary damages."

The policy required that the "Insured shall, as a condition precedent to exercising rights under this Coverage Section, give to [Defendant] written notice as soon as practicable of a Claim, but in no event later than sixty (60) days after the end of the Policy Period," or May 1, 2013. And the 2012-2013 policy also provided that all "Related Claims will be treated as a single Claim made when the earliest of such Related Claims was first made."

According to Federal, Bonner's 2012 contact with the Association constituted a "Claim," making the 2012 claim and the later-filed lawsuit "Related Claims" that must be treated as a single claim. That single claim was deemed to have first been made in 2012, meaning that when the Association provided notice of the lawsuit in October 2013, it was well past its May 1, 2013, reporting deadline—and no coverage was required.

U.S. District Court Judge John A. Mendez told the insurer to slow down.

Whether the 2012 contact between Bonner and the Association was a "Claim" under the policy and the lawsuit was a "Related Claim" entailed a factual inquiry, premature for the court to conduct on a motion to dismiss. A motion to dismiss presents the narrow, threshold question of whether the plaintiff has stated sufficient facts that, if true, entitle it to relief, the court explained.

"To determine whether the 2012 Claim and the Underlying Action are related, the Court would first need to determine the scope of each claim," Judge Mendez wrote. "However, the Court cannot reliably determine the scope of either claim based solely on the allegations and documents attached to—and referenced in—the Complaint. With regard to the 2012 Claim, the Complaint merely alleges that Bonner made a 'request for a meeting' with Plaintiff, and that Plaintiff's Board of Directors 'met with Mr. Bonner.' No further details are evident from the face of the Complaint."

The court rejected Federal's requests to consider additional documents, such as letters written by Bonner to the Association and the minutes from the meeting between Bonner and the Board of Directors. The documents were not attached to the complaint, were not referenced in the complaint, and their contents were not alleged in the complaint, the court said. A reference to the documents in an attachment to a complaint was insufficient.

Even if the documents were considered, "the analysis would be complicated by their poor quality and the ambiguity of their contents," Judge Mendez added. The letter from Bonner "is as confusing as it is lengthy," and some of the text was faded to the extent that entire phrases were illegible. "Further development of the evidentiary record is necessary to determine the scope of the 2012 Bonner claim," the court said, as well as the scope of the underlying action.

"The entirety of Defendant's motion depends on a finding that these claims are related," the court wrote. "If the claims are not related, then Plaintiff's tender of the Underlying Action to Defendant was timely and Defendant's argument fails. Also, Defendant's argument concerning the third cause of action (breach of the implied covenant of good faith and fair dealing) requires the Court to evaluate the objective reasonableness of Defendant's determination that coverage for the Underlying Act did not exist. An inquiry into the reasonableness of this determination, in turn, requires the Court to determine the reasonableness of Defendant's conclusion that the claims were related. Without a fully developed evidentiary record, the Court cannot find that such a conclusion was objectively reasonable. Thus, Defendant's motion fails with respect to each of Plaintiff's causes of action."

To read the order in The Rancho Tehama Association v. Federal Insurance Company, click here.

Court Orders Coverage as Some Allegations Fall Outside Policy Exclusion

Why it matters: A New York federal court affirmed that in order for an insurer to avoid its coverage obligations pursuant to an exclusion in the policy, it must demonstrate that the allegations of the underlying complaint cast the pleadings "wholly within that exclusion." The court found that allegations that an employee trust was underfunded did not fall "wholly within" a policy exclusion for "mishandling funds," and thus ordered the insurer to provide a defense to the trustees facing two separate lawsuits. In these lawsuits, the trustees of an employee trust were sued for allegedly violating their duties and leaving the trust underfunded by millions of dollars. The trustees tendered defense of the suits to their directors and officers' insurer, but the insurer refused, relying on a policy exclusion for the "mishandling of funds." In a coverage lawsuit filed by the trustees in New York federal court, the judge sided with the trustees. Not all of the claims asserted against the trustees related to the mishandling of funds, the court said, with other allegations that the trustees failed to take corrective actions and properly administer the trust. The insurer was obligated to provide a defense because some of the allegations fell outside of the exclusion, the judge ordered.

Detailed discussion: Executive Risk Indemnity, Inc., issued a Directors and Officers (D&O) policy to the New York State Association of Health Care Providers for a period running January 1, 2011, to January 1, 2012. The policy provided coverage for "any past, present or future director, officer [or] trustee" of the organizations and the Health Care Providers Self-Insurance Trust.

The policy featured certain exclusions, including one for claims that are "based upon, arising out of, directly or indirectly resulting from, in consequence of, or in any way involving … any commingling or mishandling of funds."

On July 8, 2011, the New York State Workers' Compensation Board sued the trustees of the Trust, alleging that the defendants acted improperly in the administration and maintenance of the trust, failing to satisfy their duties as trustees and resulting in the trust being underfunded by several million dollars. A second lawsuit with similar allegations followed.

The trustees notified Executive Risk and requested a defense for both lawsuits. Citing the exclusion for "mishandling funds," the insurer disclaimed coverage. The trustees filed suit against Executive Risk, arguing that the allegations against them did not clearly and entirely fall within the policy's exclusion.

Ruling on the dueling motions for summary judgment, the court found for the trustees. Coverage is required whenever the allegations of the complaint suggest "a reasonable possibility of coverage," U.S. District Court Judge Gary L. Sharpe wrote.

"Although ERII argues that the gravamen of the underlying actions stems from plaintiffs'—defendants in the state court actions—'mishandling of funds,' such that defense for the underlying actions would fall within the policy's exclusion clause, that argument is unavailing," the court said. "ERII fails to acknowledge the well-settled principle that, in order to rely on an exclusionary clause as a basis to disclaim coverage, an insurer must demonstrate that the 'allegations of the [underlying] complaint[s] cast the pleadings wholly within that exclusion.' "

As set forth by the trustees, "many of the allegations in the underlying complaints would appear to be plainly encompassed by the policy," the judge said.

Allegations included the failure "to take sufficient or timely corrective actions to establish the financial viability of the Trust," the failure "to properly administer the affairs of the Trust," actions by the trustees that "caused the Trust to enter into contracts and agreements that were detrimental to the Trust," and that the trustees neglected to "properly and timely inform the members of the Trust of the true financial status of the Trust." The complaints also asserted the trustees breached their fiduciary duties and failed to ensure that the trust was at all times properly capitalized.

"These allegations fall squarely within the policy's terms requiring coverage for 'Wrongful Act[s],' " Judge Sharpe wrote. "[W]hile some of the allegations and causes of action in the underlying actions may potentially constitute 'mishandling of funds,' it is clear that other allegations and causes of action plainly fall within the purview of the policy's coverage of liability for 'wrongful acts.' Accordingly, given that certain allegations are encompassed by the policy, '[it is immaterial] that the [underlying] complaint[s] against [plaintiffs] assert[] additional claims which fall outside the policy's general coverage or within exclusionary provisions,' and ERII is therefore obligated to provide coverage."

To read the decision in Balaban-Krauss v. Executive Risk Indemnity, click here.