March 2011

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                                                                                                                                    March 2011

In this issue we address significant recent decisions of interest to the insurance community in regard to (a) regulatory oversight, (b) bad faith,
(c) pollution exclusion, (d) environmental exposure, (e) aggregate limits, (f) asbestos, (g) arbitration, (h) civil rights, (i) toxic mold, (j) disclosure,
(k) waiver, (l) phishing, (m) duty of primary coverage, (n) definition of “securities claim,” (o) the “prior knowledge” condition, (p) recovery of
setoff, (q) late notice, (r) innocent insureds and (s) reinsurance.
We review decisions from the Second, Fourth, Fifth, Ninth and Tenth U.S. Circuit Courts of Appeal as well as the New York State Court of
Appeals and the Supreme Court of California.

REGULATORY OVERSIGHT                                                            In Continental Casualty Company v. Enodis Corporation, the U.S.
                                                                                Court of Appeals for the Ninth Circuit opened the door to poten-
Insurers scored a potentially significant regulatory victory in                 tial liability rulings on consequential damages and bad faith
People’s Insurance Counsel Division v. Allstate Insurance                       against an insured by a federal district court in California. The
Company, when a Maryland appeals panel ruled that an insurer                    insured brought a coverage action for a quarter of a million dollars
was not subject to regulatory sanctions regarding a decision to                 and the insured responded with a counterclaim for $2.3 million in
exclude certain geographic areas of the state as “catastrophe                   regard to underlying product liability litigation for defective fur-
prone” and uninsurable due to the increasing risk of hurricane                  naces. The court ruled that California Supreme Court authority
damage. The court stated that the regulators were in effect ask-                cited by the district court did not preclude a bad faith claim
ing the court to put on “geographic blinders” and engage in “fan-               because the alleged damages did not result entirely from a billing
tasy analysis” and held that excluding from coverage property                   dispute, and held that the insured was entitled to try to establish
located 60 miles from the ocean was not unreasonable, even                      consequential damages resulting from the method of settling the
though other carriers were not adopting the same approach,                      claims, since if proximate cause were shown there could be a
because the data supported the increasing risk. It repudiated                   recovery arising from the breach of a settlement duty to which the
dicta in a prior decision which the plaintiff had relied upon to                carrier was bound.
support its position. One of the areas we have identified for
monitoring as a potential “next asbestos” area of insurer poten-                POLLUTION EXCLUSION
tial liability is the burgeoning field of global warming. People’s
Insurance offers insurers hope that with changing weather pat-                  Decisions from Texas, Massachusetts and West Virginia refused to
terns and emerging forms of risk insurers will not necessarily be               invoke pollution exclusions to bar coverage, but decisions from
caught between a rock and a hard place in managing their new                    New Mexico, Colorado and New York found little difficulty in
exposures.                                                                      doing so.

BAD FAITH                                                                       In Dallas National Ins. Co. v. Sabic Americas Inc., an appeals
                                                                                panel in Texas held that the term “governmental authority” in a
In American Safety Casualty Insurance Company v. City of                        pollution exclusion was ambiguous and thus prevented the insur-
Waukegan, a federal district court in Illinois ruled that an insurer            er from invoking the exclusion to bar coverage. Numerous
had a duty to defend an underlying action against the insured                   underlying actions claimed groundwater pollution by methyl ter-
municipality’s police officers for false arrest (resulting in an $9 mil-        tiary butyl ether (MTBE), and the insured argued that “govern-
lion jury verdict) and had acted “unreasonably and vexatiously”                 mental authority” should be read to mean only an agency having
in response to the claim, but the carrier still avoided liability for           environmental cleanup authority, while the insurer claimed any
bad faith. The carrier was liable for all of the insured’s attorney             government agency of any type was included. The court held
fees in prosecuting the action as well as for the damage verdict                that both interpretations were reasonable, rendering the policy
itself, but it was not liable in bad faith because although the basis           term ambiguous.
it articulated for its disclaimer was invalid it did not act with mali-
cious intent or deliberately mislead the insured.                               In UniFirst Corp. v. Liberty Mutual Ins. Co., an appeals panel in
                                                                                Massachusetts found that issues of fact regarding the application
of the “sudden and accidental” exception in the policy’s pollution       ered third-party liability in regard to sudden pollution discharges
exclusion sufficed to preclude summary judgment. The underly-            regardless of whether such liability arose under CERCLA or oth-
ing claim involved chemical contamination from a dry-cleaning            erwise. The underlying action involved the release of a large
distribution operation. The court stated that a jury presented with      quantity of propane from a ship followed by the filing of hun-
all the documentation generated in discovery could come to “any          dreds of claims from local property owners. A federal district
number of conclusions” as to whether the damages resulted from           court in Louisiana granted summary judgment to the excess
one or more sudden and accidental releases.                              insurer, holding that the primary insurer could not refuse to pay
                                                                         certain defense and settlement costs because the liability associ-
In In re Mingo County Coal Slurry Litigation, a federal district court   ated with them was not imposed by CERCLA, and the Fifth
in West Virginia ruled that the insurers had a duty to defend            Circuit affirmed. Since the excess policy was specifically excess
against underlying environmental contamination claims related            to all other insurance, the duty of the excess carrier to pay
to the insured’s coal mining operations’ alleged contamination of        defense costs was immaterial and the entire obligation fell on
groundwater, but it refused to grant the insured summary judg-           the primary insurer.
ment in regard to the pollution exclusion, ruling that additional
discovery was required before any conclusive determination could         In American Commercial Lines v. Water Quality Insurance
be made.                                                                 Syndicate, the U.S. Court of Appeals for the Second Circuit dis-
                                                                         missed an appeal for lack of jurisdiction, holding that the district
In United Nuclear Corp. v. Allstate Ins. Co., a divided appeals          court’s ruling did not conclusively determine the parties’ rights
panel in New Mexico ruled that pollution discharges from a min-          and obligations regarding coverage responsibilities arising from
ing operation were not sudden and accidental and therefore no            an oil spill. The district court granted the plaintiff insured judg-
coverage was owed because the policy’s pollution exclusion was           ment on the pleadings, rejecting the carrier’s exhaustion argu-
applicable, upholding the grant of summary judgment to the               ment. The Second Circuit ruled that the district court had only
insurer. The dissent would have ruled the term “sudden and acci-         determined the scope of the insurer’s contractual obligation
dental” to be ambiguous, creating a fact issue for a jury to resolve.    under the policy, not the exact terms of the obligation. Since
                                                                         that remained to be decided, no appeal could lie.
In Allstate Ins. Co. v. Metzger, a federal district court in Colorado
invoked a policy’s pollution exclusion to bar coverage for an envi-      In OneBeacon Ins. Co. v. Newmont Mining Corp., an New York
ronmental contamination suit involving the sale of land adulter-         State appeals panel invoked the doctrine of forum non conve-
ated by waste oil by a developer. The developer’s failure to dis-        niens to reverse a trial court ruling and remove a coverage dis-
close its knowledge of illegal dumping was viewed as precisely the       pute from the New York legal system. The suit involved con-
type of claim to which the exclusion was meant to apply even             tamination at the insured’s various mining sites around the
though the exact type of toxin involved was unknown. As a                country and policies issued between 1952 and 1985. The trial
result, the court denied the insured’s request for additional discov-    court retained jurisdiction and ruled that the policies did not
ery to explore the issue.                                                have to respond based on a settlement that involved a policy
                                                                         buy-back, and that non-settling carriers were not entitled to
In State of New York v. OneBeacon Insurance Co., a New York              contribution from the settling insurers under New York’s pro
State trial court held that a pollution exclusion barred coverage        rata allocation scheme. The appeals panel held that
for a petroleum spill because it expressly applied to pollutants         Washington State was a better forum for the dispute since all
“transported or handled” by the insured and because petroleum            the parties could be before the court there. It stated that it had
was obviously a pollutant within the meaning of the exclusion. It        a responsibility to promote judicial efficiency and discourage
rejected the insured’s contention that the drafting of an exception      duplicative and piecemeal litigation.
to the exclusion created ambiguity, holding that the exception
was clear as well.                                                       AGGREGATE LIMITS
ENVIRONMENTAL EXPOSURE                                                   In Union Carbide v. Affiliated FM Ins. Co., the New York Court
                                                                         of Appeals, the state’s highest tribunal, held that the aggregate
In Industrial Enterprises Inc. v. Penn America Ins. Co., the U.S.        limits of an insured’s excess policy applied on an annual basis
Court of Appeals for the Fourth Circuit held that liability under        rather than to the entire three-year term of the policy, consis-
CERCLA was not liability for “property damage” within the                tent with the policy’s “follow-the-form” clause. The underlying
meaning of a CGL insurance policy, and reversed a ruling by a            claims involved asbestos liability in regard to policies issued in
federal district court in Virginia in favor of the insured. Instead,     the 1970s and issued using subscription form policies that allo-
the divided panel ruled that the liability was regulatory in nature,     cated shares of liability to various insurers. The trial court had
i.e., for response costs. But the dissent argued that EPA had            so held, but it was reversed by an appeals panel (Third
imposed an obligation on the insured to rectify property damage          Department). The Court of Appeals stated that it was “implau-
incurred by third parties and that this should make the claim            sible” that an insured with a large and complex insurance pro-
potentially coverable.                                                   gram would have bargained for policies that differed as to the
                                                                         time over which the risk was to be spread. Moreover, it ruled
In In re Taira Lynn Marine, the U.S. Court of Appeals for the            that annualization was the “universal custom of the industry”
Fifth Circuit held that an excess carrier was entitled to reim-          and that the carrier’s reliance on the language of the policy
bursement from a marine insurer because the marine policy cov-           itself was unconvincing.
ASBESTOS                                                              DISCLOSURE
In Ford Bacon & Davis LLC v. Travelers Ins. Co., the U.S. Court       In AIU Ins. Co. v. Certain Underwriters of Lloyd’s, a state trial court
of Appeals for the Fifth Circuit affirmed the ruling of a federal     in New York required an insurer to produce for inspection, in an
district court in Texas that an insurer had no duty to defend a       action between two insurers over whether certain asbestos risks
successor company against underlying asbestos liability suits in      had been transferred, documents prepared by a carrier’s attorney.
West Virginia because an asset purchase agreement excluded            The court concluded that the work-product privilege had been
the transfer of such liabilities and because Texas law does not       waived after the attorney referred to certain documents during a
recognize the “product-line successor liability rule.” Where,         deposition in a manner that materially increased the likelihood
the court stated, an entity purchasing assets has expressly not       that the deposing party would obtain the information, and putting
assumed liability for the assets then liability, under Texas law,     the information at issue in the case. The court required the wit-
does not extend by operation of law and the carrier’s duty is not     nesses to both answer questions and produce any documents with-
triggered.                                                            held in regard to attorney analysis of the exhaustion of coverage.

ARBITRATION                                                           In ACandS Asbestos Trust v. Hartford Accident and Indemnity Co.,
                                                                      a Delaware bankruptcy court dismissed actions filed by an asbestos
In Sturgeon v. Allied Professionals Ins. Co., a Missouri appeals      trust seeking to prohibit insurance companies from obtaining dis-
panel ruled that an arbitration and choice-of-law clause in a pro-    covery from related liability proceedings, finding that it lacked
fessional liability insurance policy was not enforceable. In an       jurisdiction to hear the claims. Labeling the insurer demands
underlying action, a masseuse was sued when her massage table         “massive and intrusive” the trust sought a protective injunction
collapsed and caused personal injury; the suit was ultimately dis-    from “discovery that no tort system participant would have access
missed. The insured brought a coverage action and the insurer         to.” The bankruptcy court determined that although it had issued
sought arbitration, but the trial court refused to grant it, invok-   the orders creating the trusts, it did not have jurisdiction to limit
ing the McCarran-Ferguson preemption exception to the                 discovery proceedings in other courts following that determina-
Federal Arbitration Act and a Missouri statute barring arbitra-       tion and accordingly dismissed the trust requests.
tion in insurance policies, and the appellate panel agreed.
In ESAB Group Inc. v. Arrowood Indemnity Co., a federal district
court in South Carolina ruled that a welding rod liability dispute    In Fox v. Allstate Ins. Co., a New York State trial court found
was subject to arbitration in Sweden due to policy provisions call-   there was an issue of fact as to whether an insurer had waived its
ing for such to occur. However, since two of the policies in the      rights under the policy’s time limitation provision. The policy
group did not contain express arbitration provisions, even though     required that an action claiming coverage be filed within two
they contained Swedish choice-of-law clauses, they had to be lit-     years of the incident, and the court held that since the insurer was
igated in the United States as filed.                                 involved in investigations and settlement discussions during this
                                                                      period a question of fact had been created as to whether the lim-
CIVIL RIGHTS COVERAGE                                                 itations period should be deemed to have been tolled as a result of
                                                                      the insurer’s conduct lulling the insured into inaction.
In Aspen Specialty Insurance Co. v. Wilson Borough, a federal dis-    Accordingly, summary judgment was denied to the insurer.
trict court in Pennsylvania held that underlying civil rights
claims against the insured grew out of a bodily injury that was       PHISHING
excluded from coverage under the applicable police professional
liability policy, and hence there was no coverage. In the under-      In Greenwich Ins. Co. v. Media Breakaway, the U.S. Court of
lying action, a surviving husband brought a wrongful death            Appeals for the Ninth Circuit affirmed a ruling that sided with an
action against the police for negligently inducing a high-speed       insurer and excluded coverage claims related to Internet “phish-
chase that caused the fleeing felon to crash into his wife’s auto-    ing” tactics from the subject D&O policies. The court held that
mobile, killing her. The court held that “personal” injury was        broadly-worded exclusions for intentional conduct resulting in ill-
within the purview of the policy but that “bodily” injury was         gotten profits were sufficient to include phishing.
outside it. The court reasoned that merely because personal
injury can arise out of a violation of civil rights does not mean     DUTY OF PRIMARY COVERAGE
that all civil rights violations result in personal injury rather
than bodily injury.                                                   In Fieldston Property Owners Association v. Hermitage Ins. Co., the
                                                                      New York Court of Appeals reversed an appellate ruling that the
TOXIC MOLD                                                            CGL policy was primary and the D&O policy was excess because
                                                                      of an “other insurance” clause in the D&O policy. The appellate
In Clarendon America Ins. Co. v. Southern States Plumbing Inc., a     panel had concluded that the “other insurance” clause only applied
federal district court in Louisiana ruled that mold exposure dam-     when concurrent coverage is available, and since the two policies
ages were not covered by the policies at issue because they were      at issue insured different risks they were not concurrent. Though
outside the policy period and because the “work product” and “fun-    stating that the panel decision was appealing from an equitable
gus” exclusions in the insured plumber’s policy barred coverage.      standpoint, the Court of Appeals concluded that it could not
                                                                      rewrite the policies to achieve an equitable result.
DEFINITION OF “SECURITIES CLAIM”                                         defense. In East Texas Medical Center Regional Healthcare System
                                                                         v. Lexington Ins. Co., a federal district court in Texas held that a
In XL Specialty Ins. Co. v. Loral Space & Communication Inc., a          medical malpractice insurer had failed to provide sufficient
divided appellate panel in New York ruled that an underlying class       notice to support a jury finding of prejudice resulting from a six-
action against the insured did not involve a “securities claim” and      month delay in notice, since the carrier had notice more than a
reversed a lower court decision finding coverage for attorneys fees      year before the case settled and could have actively participated
in that action, although the insured was entitled to coverage for        in the defense, losing only the opportunity to participate in a
fees in a related (and consolidated) associated shareholders’ deriv-     few depositions. And in Sherwood Brands Inc. v. Great American
ative action. The claims in the main action were not derivative          Ins. Co., an appeals panel in Maryland reversed a trial court rul-
and did not allege securities law violations, only a breach of fidu-     ing in an insurer’s favor based on a ninety-day notice provision
ciary duty by the company’s directors. The dissent did not dis-          in the policy, again finding that the insurer had not made the
agree with that contention, but would have found that the attor-         requisite showing of prejudice. The court held that a Maryland
ney fees did not constitute an insurable “loss” within the meaning       statute, which is rare and at odds with the provisions of most
of the policy.                                                           other states, requiring a showing of prejudice applied even to
                                                                         claims-made policies.
                                                                         INNOCENT INSUREDS
In Cohen-Esrey Real Estate Services Inc. v. Twin City Fire Ins. Co.,
the U.S. Court of Appeals for the Tenth Circuit ruled that a prior       In Century National Ins. Co. v. Garcia, the Supreme Court of
knowledge condition in an errors and omissions policy barred cov-        California unanimously ruled that an insurer owed a duty of cov-
erage of an underlying negligence claim arising from employee            erage to innocent insureds for damages that resulted from arson
embezzlement. The employer had discovered a minor misuse of              by the insured’s son in their home, regardless of their policy’s
an expense account the year before, but had not terminated the           intentional acts exclusion. In doing so, it reversed both the trial
employee, and the insurer asserted that this triggered the prior         court and an appeals panel which had sided with the insurer.
knowledge condition. The Tenth Circuit agreed. It held that it           The court based its decision on California statutes requiring that
was not necessary to show that the insured could have predicted          the fire insurance comply with certain form coverage standards
the type of fraud that later ensued so long as it had no foolproof       and concluded that denying coverage to innocent insureds was
defense to a claim of mismanagement.                                     not consistent with these standards.

RECOVERY OF SETOFF                                                       REINSURANCE

In In re Ancillary Receivership of Reliance Ins. Co., an appeals panel   In ACSTAR Ins. Co. v. Clean Harbors Inc., a federal district court
in New York State held that a $1.3 million setoff for defective          in Connecticut held that a reinsurer was not prejudiced by an
work deducted from a construction management company’s                   insured’s settlement of an environmental contamination suit
underlying $5 million quantum meruit award was not recoverable           with an insurer because the insurer’s policy contained a pollution
under an environmental liability insurance policy because it did         exclusion that barred coverage for the underlying petroleum spill
not arise from the company’s rendering of professional services.         by a subcontractor of the insured. The insurer settled with the
The court held that the setoff was not a monetary judgment or            subcontractor and the reinsurer argued that the insured had prej-
compensatory damages against the insured and was not covered             udiced its subrogation rights. The court held that the reinsurer
under the professional liability provisions of the policy as a claim     had no such rights under the “made whole” rule, otherwise a sin-
for professional negligence.                                             gle payment by the insurer would result in a general assignment
                                                                         of claims, transferring an undue risk to the insured and unfairly
LATE NOTICE                                                              benefiting the insurer. Moreover, even if subrogation rights had
                                                                         existed, the court ruled that the existence of a pollution exclu-
Two recent decisions both embraced the notion that an insurer            sion in the subcontractor’s policy meant there could be no preju-
must show prejudice in order to take advantage of a late notice          dice resulting from a settlement.

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