Policy Observer - December 2013

by Orrick, Herrington & Sutcliffe LLP

Time for a Change? California Revisits Henkel on Coverage for Contractually Acquired Liabilities

The California Supreme Court’s unexpected decision earlier this year to accept review of Fluor Corp. v. Superior Court, 208 Cal. App. 4th 1506 (2012), rev. granted, has both policyholders and insurers speculating about whether the court will overturn its controversial decade-old decision in Henkel Corp. v. Hartford Accident & Indem. Co., 29 Cal. 4th 934 (2003). In Henkel, the court disapproved the transfer of insurance rights by operation of law in connection with a corporate transaction. Henkel held that where liability is acquired by contract, and not by operation of law, insurance coverage likewise does not transfer by operation of law. The policies in Henkel contained a “no assignment” clause, which prohibited the assignment of an “interest” under the policies without the consent of the insurer. Because Henkel had not obtained the insurer’s consent, the court held under California law that the attempted contractual assignment was ineffective. Consequently, when Henkel was sued for injuries caused by defective products manufactured by the predecessor, it was not entitled to either a defense or indemnity with respect to such claims.

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News Briefs

Pennsylvania Appellate Court: Commercial Liability Insurance Covers Product Defects That Cause Damage to Property Not Manufactured By Policyholder

Reversing a lower court decision, the Superior Court of Pennsylvania ruled on December 3 that an umbrella liability insurer must cover a manufacturer’s liabilities when homeowners sued for product defects that allegedly caused physical damage to their homes. Indalex Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA, 2013 PA Super 311 (Dec. 3, 2013). The plaintiff homeowners alleged that defects in the policyholders’ windows and doors caused leaks, mold and cracked walls in their homes. The trial court ruled that there was no covered occurrence, relying on Kvaerner Metals Div. of Kvaerner U.S., Inc. v. Commercial Union Ins. Co., 908 A.2d 888 (Pa. 2006), where the Pennsylvania Supreme Court found that a commercial liability policy did not cover claims for faulty workmanship. But the Superior Court reversed—and in so doing, carved out an important exception from Kvaerner—finding coverage because the homeowners’ suit did not merely allege that the doors and windows were defective but also that these defects had damaged their homes.

California Supreme Court Lets Stand Appellate Decision Allowing Insurers to Avoid Paying Policyholder’s Independent Counsel Fees in Environmental Action

The California Supreme Court recently let stand a holding that an insurer’s reservation of rights did not automatically entitle a policyholder to independent counsel. Federal Ins. Co., et al. v. MBL, Inc., Case No. H036296 (Cal. Ct. App. Aug. 26, 2013). The court denied review of a holding that a dry cleaning chemical supplier was not entitled to Cumis counsel in an environmental suit. California law recognizes a conflict of interest when an insurer reserves its rights on a coverage-dispositive issue, and insurer-appointed defense counsel can control the disposition of that issue. In that situation, the policyholder is entitled to retain independent counsel to defend the suit. When MBL sought coverage from its insurers for an environmental action, its insurers agreed to defend, but reserved their rights to deny coverage if the property damage occurred outside of the policy period. Some insurers also reserved rights based on their policies’ pollution exclusions. The Court of Appeal rejected MBL’s argument that these reservations entitled it to Cumis counsel, holding that defense counsel could not control the date when property damage occurred. The court also held that application of the absolute pollution exclusion turned on whether the loss arose out of a government clean-up order, a factual question that defense counsel could not control.

Insurer Ordered to Cover Investment Losses Stemming from Madoff Ponzi Scheme

A New York judge recently held that an insurer must cover the losses of two investment vehicles that were victims of Bernard L. Madoff’s Ponzi scheme, ruling that the losses did not fall under a broker exclusion that barred coverage for the dishonest securities brokering of a nonemployee. U.S. Fire Ins. Co. v. Nine Thirty FEF Investments, LLC, Index No. 603284/2009, Dkt. No. 129 (N.Y. Sup. Ct., Oct. 1, 2013). The insurer argued that the policy excluded losses caused by dishonest acts of registered outside investment brokers whether or not they were acting in a brokerage capacity. However, the court rejected this argument because Madoff ran a Ponzi scheme, not a brokerage operation. The court specifically noted that Madoff stole the money to which he was entrusted when he received it, but that the money was never invested as he represented to his clients.

Sixth Circuit Reverses Lower Court’s Decision to Deny Cleveland Indians Coverage for Fatality at Pregame Incident

An insurance broker may be liable to the Cleveland Indians as an additional insured for broker negligence in failing to obtain coverage the team’s vendor requested for a pregame event in which a spectator was killed by a falling inflatable slide. Cleveland Indians Baseball Co. v. New Hampshire Ins. Co., 727 F.3d 633 (6th Cir. 2013). The Sixth Circuit overturned the district court’s holding that the broker was not liable for negligence in failing to obtain a policy that specifically covered inflatable slides. National Pastime Sports, which contracted with the Indians to hold the pregame event, applied for coverage through CSI Insurance Group, noting that inflatable materials would be used during the event. The Sixth Circuit asserted that Michigan law does not require a showing that the broker had a special relationship with the plaintiff—here, the Indians—to demonstrate that it had a duty of reasonable care. Rather, providers of professional services, such as insurance brokers, had an independent duty of care toward third parties where the harm was foreseeable and where the defendant had specific knowledge that its action might harm a specified third party.

Illinois Appellate Court Holds Indemnity Coverage Potentially Available Even Where Defense Coverage Is Not

The Illinois Appellate Court recently affirmed an insurer’s obligation to indemnify its insured under a commercial general liability and umbrella liability policy, even where the insurer did not have a duty to defend. Selective Ins. Co. of South Carolina v. Cherrytree Cos., Inc., No. 3-12-0959 (Ill. App. Nov. 4, 2013). The Appellate Court rejected the trial court’s finding that the insurer’s duty to provide a defense was a prerequisite to indemnity coverage. The trial court relied on case law that held that if the duty to defend does not attach because a claim is not even potentially covered, there could be no indemnity coverage for that same uncovered claim. In reversing the trial court, the Appellate Court explained that this holding was fact-specific and did not establish a general rule requiring defense coverage as prerequisite to indemnity coverage. The court found that, while the policy’s defense obligation required initiation of formal proceedings, the indemnification provision did not. As a result, the insured could seek indemnity coverage for claims it settled prior to the commencement of litigation.

Texas High Court Requires Insurer to Show Prejudice to Avoid Coverage for Unilateral Settlements

The Texas Supreme Court recently extended its jurisprudence requiring an insurer to prove prejudice when it attempts to avoid coverage due to a policyholder’s alleged breach of policy terms. Lennar Corp., et al. v. Markel Am. Ins. Co., No. 11-0394 (Tex. Sup. Ct. Aug. 23, 2013). Upon learning that the siding it had installed was defective and frequently led to water damage, the insured home builder in Lennar proactively repaired damage to several hundred houses it had built. The insurer argued that the insured’s actions were voluntary and violated the policy’s requirement that the insurer consent to such actions. But the Texas Supreme Court held that “general contract law” principles require an insurer to show that the policyholder’s breach was material and “significantly impaired the insurer’s position.” Because the jury determined that the Lennar’s efforts to stem the potentially worsening home damage had not resulted in higher damages than the insurer’s preferred approach (of waiting for the homeowners to sue), the court found that any breach was not material, and the insurer could not avoid coverage.

New York Federal Court Strictly Enforces Prompt Notice Requirement, Refuses to Require Showing of Prejudice

A federal district court strictly applied a policy requirement that the policyholder notify the insurer of a potential claim “as soon as practicable,” even under a claims-made and reported policy and even where New York statute has abrogated a common law rule requiring strict construction of that policy term. Indian Harbor Ins. Co. v. City of San Diego, No. 12-cv-05787-JGK (S.D.N.Y. Sept. 25, 2013). The policyholder argued that its delay of up to 31 months did not render its notice untimely, because it was still delivered within the “claims-made and reported” policy period. The court found that the insurer should benefit from the provision requiring that notice must be delivered “as soon as practicable” so that it could investigate and assess the claims while the evidence was at its freshest. The court rejected the insured’s argument that a 2008 change to New York’s Insurance Law required the insurer to demonstrate prejudice as a result of late notice, holding that Section 3420 of New York’s Insurance Law applies only to policies that were “issued or delivered” in New York. Here, although the policy’s choice of law provision designated New York law, because the policy was issued in Pennsylvania and delivered in California, the court found that the New York statute did not apply.

Claims Bar Dates Impending for Atlantic Mutual and Lumbermens; OIC and EAIC Increase Payment Percentages for Creditors

The Liquidator of the Atlantic Mutual Insurance Company has vacated the September 30, 2013 final bar date and set December 15, 2013 as the final bar date for insureds to present claims against the insurer.

The Lumbermens Mutual Group companies (Lumbermens Mutual Casualty Company, American Manufacturers Mutual Insurance Company, and American Motorists Insurance Company) set November 10, 2014 as the proof of claim filing deadline for all policyholder claims. Policyholders may still file contingent proofs of claim, but such contingent claims must be liquidated by November 10, 2015 in order to participate in distributions from the estates.

OIC Run-Off Limited (“Orion”) and London and Overseas Insurance Company Limited (“L&O”), insolvent London Market insurers, recently announced that they will increase the payment percentage for creditors with agreed claims by 1%. This increase brings the total percentage paid to date for agreed claims to 58%. Payments are expected within 90 days. Creditors with agreed qualifying ILU claims, however, will continue to be fully paid.

Another insolvent London Market insurer, English & American Insurance Company Limited (“EAIC”), announced a 3% increase in the payment percentage for creditors with agreed claims, bringing the percentage paid to date for agreed claims to 48%. Payments are expected within 90 days.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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