Policyholder Takes the Insurer’s Bait and Loses Coverage

by Nossaman LLP

Beware the Trojan Horse: an agreement to defend based on reservations followed, in short order, by declaratory relief actions.  The policyholder’s defender may be in disguise.

In an interesting Order coming from the United States District Court in Western District of Washington, case no C13-1014 (National Union et al v. Coinstar), National Union skillfully avoided a bad faith claim by timely agreeing to defend a series of troublesome class actions claiming breach of privacy, with the only caveat an insurance defense rate, and based on a reservation of rights.  The offered rate was likely less than ½ the market rate insured’s counsel were charging to defend relatively complex and far reaching class actions filed across the country. The pretense of good faith was then followed by both a slow pay of defense fees, and a fast and efficient filing of a series of declaratory relief actions, which achieved the goal of Court opinions affirming no duty to defend these expensive class actions.

Several of the underlying lawsuits alleged invasion of privacy related to violation of the Video Rental Privacy Act (“VRPA”), enacted as a federal law and as a state law (barring disclosure of personally identifiable information about the customers) and the Song-Beverly Act (in connection with a California action barring requesting personal information when taking credit card payments, such as zip codes or email).  All of the lawsuits were tendered to National Union for a defense under the personal and advertising provisions of the policy, which insured against “oral or written publication…that violates a person’s right of privacy.”

The policies each also contained a troublesome exclusion, virtually wiping out such coverage, and now seen more frequently, barring coverage for violation of statutes applied to the sending or transmitting of information.  The precise wording of this exclusion is informative:

“Exclusion-Violation of Statutes in Connection with Sending, Transmitting, or Communicating Any Material Or Information

This insurance does not apply to any loss, injury, damage, claim, suit, cost or expense arising out of or resulting from, caused directly or indirectly, in whole or in part by, any act that violates any statute, ordinance or regulation of any federal, state or local government, including any amendment of or addition to such laws that addresses or applies to the sending, transmitting or communicating of any material or information, by any means whatsoever.”

By word count alone, it is evident that this exclusion significantly narrows, if not eliminates altogether, breach of privacy coverage, which is becoming ever more crucial for retail businesses.

By agreeing to defend, including accepting the lawyers the insured had already engaged, National Union avoided bad faith claims, which may have estopped its later declaratory relief lawsuits seeking declarations of no coverage.

This scheme was almost completely successful: National Union could claim to be acting in good faith by agreeing to this limited defense, even though at the same time it delayed any payments for almost a year.  Under Safeco Ins. Co. v. Butler 823 P. 2d. 499, 506 (Wash.1992), if the insured prevails on the bad faith claim, and the insurer fails to rebut the presumption of harm, “the insurer is estopped from denying coverage.” National Union made a good enough record of agreeing to defend and making some token payments—so that the insured could only complain of late payments—not sufficient in this case to sustain a claim of bad faith.

The Court ultimately determined there was no duty to defend the several class actions relating to violation of the VRPA because each of the National Union policies contained the Exclusion-Violation of Statutes in Connection with sending, Transmitting or Communicating Any Material Or Information.  As to the California action based on the violation of the Song-Beverly Act, the Court determined that the claims did not fall within the personal and advertising injury coverages, because there was no publication, only the gathering of personal information.

What about the defense fees payable by National Union until these determinations of no coverage?  In Washington, the insurer must defend until the Court declares no defense is owed.  National Surety Corp. v. Immunex Corp.,  297 P. 3d 688, 693-94 (Wash. 2013).  National Union argued it had “unlimited” discretion to determine the amounts it would pay, based on standard duty to defend language in its policies.  Fortunately, the Court found to the contrary: the measure is what is reasonable.  “Thus, barring a contract term to the contrary, National Union does not have unbounded discretion to unilaterally limit the rates it will pay.”  The Court found no attorney fee rates were set out in the policies, and National Union must pay reasonable defense fees as to be determined by the trier of fact (not on summary judgment).

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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