Excess Insurance

Excess insurers may be interested in the recently reported decision of ACE INA Insurance v. Associated Electric & Gas Insurance Services Ltd., [2012] O.J. No. 6500 (S.C.J.).

ACE insured Toronto Hydro, which was sued over an explosion that occurred in the underground parking of a high-rise apartment building.  AEGIS was the excess insurer.  Although there was no explicit duty to defend under the AEGIS policy, ACE brought an application that AEGIS had a duty to pay defence costs pursuant to the doctrine of equitable contribution.

The AEGIS policy was an "indemnity policy" rather than a "liability policy".  Under its policy, AEGIS limited its indemnity obligation where there is other insurance, and limited its duty to indemnify to defence costs incurred by the insured, not those incurred by a third-party such as ACE.  Defence counsel had been appointed by ACE rather than the insured.  AEGIS's obligation was only to indemnify defence costs at the end of the litigation, where the costs were not covered by other insurance.    

Justice C.J. Brown rejected the argument that AEGIS had an equitable duty to contribute to defence costs despite the clear wording of the policy.  There is no equitable obligation to defend where an excess policy precludes a duty to defend.  In addition, a relevant factor was that any defence costs paid by AEGIS would reduce the policy limits available to the insured so there was potential prejudice to Toronto Hydro. 

Georgia Court Holds No Coverage for Restitutionary Amounts

In its recent decision in Fidelity Bank v. Chartis Specialty Ins. Co., 2013 U.S. Dist. LEXIS 110935 (N.D. Ga. Aug. 7, 2013), the United States District Court for the Northern District of Georgia had occasion to consider whether an insured was entitled to indemnification for return of ill-gotten gains.

Chartis insured Fidelity under a Management and Professional Liability for Financial Institutions Policy.  Fidelity sought coverage for an underlying class action lawsuit brought by customers alleging that the fees charged by Fidelity for overdrafts amounted to a usurious interest charge in violation of Georgia law.  The underlying suit pled causes of action against Fidelity for violations of Georgia’s civil and criminal usury laws, for conversion, and for money had and received.  Chartis agreed to reimburse Fidelity for its defense in the underlying suit, but took the coverage position that Fidelity would not be entitled to indemnification for any amounts awarded.  Fidelity subsequently settled with the underlying plaintiffs and then commenced a declaratory judgment action against Chartis.  Specifically, Fidelity sought indemnification of the settlement amounts pursuant to the policy’s professional liability part, under which Chartis agreed to pay losses resulting from wrongful acts of Fidelity in the rendering or failure to render “professional services,” a term defined, in relevant part, to mean services, including online banking services, provided to clients for customers or clients in return for a fee.

On motion for summary judgment, Chartis argued that it had no indemnity obligations to Fidelity for several reasons.  First, Chartis argued that the Fidelity’s conduct was not a “wrongful act” as that term was defined by its policy (i.e., an act, error or omission), but instead a deliberate business decision to charge overdraft fees.  Chartis also argued that the underlying suit did not arise out of Fidelity’s “professional services.”  More significantly to the court, Chartis argued that the settlement amounts were uninsurable as a matter of law and that in any event, the policy contained an exclusion stating that Chartis is not:

… liable to make any payment for Loss in connection with any Claim made against any Insured . . . alleging, arising out of, based upon or attributable to, directly or indirectly, any dispute involving fees, commissions or other charges for any Professional Service rendered or required to be rendered by the Insured, or that portion of any settlement or award representing an amount equal to such fees, commissions or other compensations; provided, however, that this exclusion shall not apply to Defense Costs incurred in connection with a Claim alleging a Wrongful Act;

While the court rejected Chartis’ first two arguments concerning professional services and wrongful acts, it found the latter two arguments compelling.  Requiring Chartis to indemnify Fidelity for amounts it wrongfully charged its clients in the first instance, explained the court, would result in a windfall since such a ruling would mean that Fidelity “is free to collect fees and make profits from its customers through illegal conduct, and the insurer is on the hook when the customers sue while Plaintiff keeps the ill-gotten gains.”  While the court acknowledged the lack of any Georgia case law addressing the issue, it observed that courts in many states have held that one cannot insure against the risk of having to return money or property wrongfully acquired.  Ultimately, however, in an effort to avoid announcing a “new” rule under Georgia law, the court reached its holding on the basis of the policy exclusion, which it noted “speaks to exactly this type of claim.”  Thus, the court held that Chartis had no indemnity obligation in connection with the underlying suit. 

New York Court of Appeals Sets Forth New Rule for Breach of Duty to Defend

In its recent decision in  K2 Investment Group, LLP v. American Guarantee & Liability Ins. Co., 2013 N.Y. LEXIS 1461, 2013 NY Slip Op. 4270 (NY June 11, 2013), New York's Court of Appeals – New York’s highest court – announced a new rule regarding the consequences for breaching a duty to defend under New York law.

Prior to the decision in K2, New York courts at both the state and federal level consistently rejected the notion that by having breached a duty to defend, an insurer is estopped from relying on coverage defenses for the purpose of contesting an indemnity obligation.  See, e.g., Servidone Construction Corp. v. Security Ins. Co., 488 N.Y.S.2d 139 (NY 1985) (holding it is impermissible for a court to enlarge a policy’s coverage on the basis of an insurer’s breach of a duty to defend); Hotel des Artistes, Inc. v. Gen. Accident Ins. Co. of Am., 775 N.Y.S.2d 262 (1^stDep’t 2004); Robbins v. Michigan Millers Mut. Ins. Co., 633 N.Y.S.2d 975 (3d Dep’t 1997); Hugo Boss Fashions, Inc. v. Fed. Ins. Co., 252 F.3d 608 (2d Cir. 2001). In fact, this rule was reaffirmed as recently as June 11, 2013 – the same day as the K2 decision – by the United States Court of Appeals for the Second Circuit in CGS Industries, Inc. v. Charter Oak Fire Ins. Co., 2013 U.S. App. LEXIS 11700 (2d Cir. June 11, 2013). 

The New York Court of Appeals’ June 11, 2013 decision in K2, however, departs from this long-established jurisprudence.  K2 involved loans made by two limited liability companies to a third company, Goldan.  The loans were to be secured by mortgages, but the mortgages were not properly recorded.  The two LLCs subsequently brought suit against Goldan and its two principals, one of whom, Jeffrey Daniels, was an attorney.  The suit asserted a claim of legal malpractice against Mr. Daniels for having failed to record the mortgages.  Mr. Daniels sought coverage from his errors and omissions carrier, American Guarantee, but American Guarantee disclaimed coverage on several grounds. Mr. Daniels subsequently defaulted in the underlying action, and plaintiffs took a judgment in excess of the policy limits of the American Guarantee policy.  The LLCs then asserted a direct action against American Guarantee for breach of contract and failure to settle within policy limits.

American Guarantee moved for summary judgment on the basis of its policy’s “business enterprise” exclusions. It argued that the claim against Mr. Daniels arose out of his capacity or status as a member or owner of Goldan, and that as such, the exclusions applied.  The trial court granted summary judgment in favor of the claimants, and on appeal, New York’s First Department held that the exclusions were “patently inapplicable,” at least for duty to defend purposes, since the essence of the underlying claim was that Mr. Daniels committed legal malpractice.  The Appellate Division, however, was divided as to whether the exclusions applied for the purposes of American Guarantee’s duty to indemnify. 

On appeal to the New York Court of Appeals, American Guarantee essentially conceded that it had breached its duty to defend Mr. Daniels, but argued that it could still rely on the exclusions to avoid a duty to indemnify.  The Court of Appeals disagreed, holding that by having breached its duty to defend Mr. Daniels, American Guarantee “lost its right” to rely on the exclusions for indemnity purposes.  Relying on its decision in Lang v. Hanover Ins. Co., 787 N.Y.S.2d 211 (NY 2004) – a case involving the insurer’s right to contest the insured’s liability for underlying loss after breaching a duty to defend – the court articulated its new rule:

… we now make clear that Lang, at least as it applies to such situations, means what it says: an insurance company that has disclaimed its duty to defend "may litigate only the validity of its disclaimer." If the disclaimer is found bad, the insurance company must indemnify its insured for the resulting judgment, even if policy exclusions would otherwise have negated the duty to indemnify. This rule will give insurers an incentive to defend the cases they are bound by law to defend, and thus to give insureds the full benefit of their bargain. It would be unfair to insureds, and would promote unnecessary and wasteful litigation, if an insurer, having wrongfully abandoned its insured's defense, could then require the insured to litigate the effect of policy exclusions on the duty to indemnify.  (Emphasis supplied.)

The K2 Court conceded that there may be exceptions to this new rule, such as where public policy precludes indemnification for an underlying loss.  Further, the ruling appears limited in its reach to consideration of whether exclusions can apply after a duty to defend has been breached.  Presumably, this rule will not apply where the underlying loss is covered in the first instance, i.e., not when the loss falls outside the scope of a policy’s insuring agreement. These and other questions, and the reach of K2, will undoubtedly be the subject of future controversy and litigation.

Florida Court Holds Insurer Has Duty to Indemnify Legionella Bacteria Claim

In Westport Ins. Corp. v. VN Hotel Group, LLC, 761 F. Supp. 2d 1337 (M.D. Fla. 2010), the United States District Court for the Middle District of Florida held that a general liability carrier had a duty to defend its insured in connection with a wrongful death lawsuit arising out of a hotel guest’s exposure to Legionella bacteria.  Among other things, the court held that such bacteria did not fall within the policy’s pollution exclusion.  More recently, in its decision Westport Ins. Corp. v. VN Hotel Group, LLC, 2011 U.S. Dist. LEXIS 117215 (M.D. Fla. Oct. 11, 2011), the court considered joint motions for summary judgment as to whether the insurer had a duty to indemnify with respect to such claims.

The insurer, Westport, argued that Legionella bacteria qualifies as a contaminant for the purpose of its policy’s pollution exclusion.  While the court rejected this very argument in its prior ruling, Westport argued that reconsideration was warranted based on recent decisions by the Eleventh Circuit Court of Appeals in Maxine Furs, Inc. v. Auto-Owners Ins. Co., 426 F. App’x. 687 (11^th Cir. 2011) (holding that curry aroma constituted a contaminant for the purpose of a pollution exclusion) and the Middle District of Florida in Markel Ins. Co. v. Florida West Covered RV & Boat Storage, LLC, No. 8:09-cv-2427-T-27TGW (M.D. Fla. Mar. 9, 2011), aff’d, 2011 U.S. App. LEXIS 16552 (holding that pollution exclusion applied to bacterial infection caused by millings from roadwork). The Westport court nevertheless distinguished both cases on the basis that neither involved bacteria.  Bacteria, explained the court, are living organisms not readily classified as solid, liquid, gaseous or thermal substances as required by the policy’s pollution exclusion.  Accordingly, the court reiterated its prior ruling that the pollution exclusion did not apply to the underlying suit.

The Westport court also revisited its prior ruling on the policy’s Fungi or Bacteria exclusion, which by its title alone seemed applicable to a claim arising out of exposure to Legionella bacteria.  The exclusion, however, applied only to “… bacteria on or within a building or structure, including its contents … .”  The underlying plaintiff was exposed to Legionella bacteria while in the hotel’s spa tub.  The court held that a spa tub did not qualify as a “structure,” which the court defined as “an edifice or building of any kind.”  The court further held that even if the spa tub could qualify as a “structure” for the purpose of the Fungi or Bacteria exclusion, the exclusion had an exception for bacteria “that are, are on, or are contained in, a good or product intended for bodily consumption.”  The court reasoned that the term “consumption” in this exclusion was not limited to actual ingestion, but instead meant “the utilization of economic goods in the satisfaction of wants.”  Thus, explained the court, the underlying plaintiff had consumed the hot tub water not in the sense of drinking it, but “to satisfy a desire or want.”  As such, the court held that the exception to the exclusion was applicable even if the tub could be considered a structure.

Court of Appeal Comments on s. 132 of the Insurance Act

The Court of Appeal recently commented on s. 132 of the Insurance Act. Section 132 provides that a person who obtains a judgment against an insured person which has not been satisfied may recover that amount from the insured’s insurer.

In Walker v. Sovereign General Insurance Co., [2011] O.J. No. 4106 (C.A.), the Walkers obtained a judgment against Sun Shelters Industries Inc. for damages sustained in a parking lot slip and fall. Sun Shelters went bankrupt and could not pay the judgment, so the Walkers brought an action under s. 132 against Sun Shelters’ insurance company, Sovereign. Sovereign’s position was that it did not receive proper notice as required under the CGL policy and as a result was not required to defend the action or indemnify Sun Shelters or the Walkers.

The Court of Appeal held that notice of a claim can be given either by the insured or by a person on behalf of the insured. In this case, notice was given to Sovereign by a co-defendant. The Court noted that if notice is given by someone other than the insured, the person should have sufficient proximity to give adequate details of the claim:

36 Given its purpose and importance, if the notice is to be given for an insured instead of by the insured itself, the person giving it should have sufficient proximity to the claim to have knowledge of the information required by s. 3(a). Emshih was just such a person. It owned the property where the accident occurred; it was a defendant in the original action; and it cross-claimed against Sovereign's insured. In giving notice to Sovereign, Emshih was giving notice for Sun Shelters as contemplated by s. 3(a) of the policy.

Sovereign had actual notice of the claim and made a conscious decision not to defend. If the insurer had no knowledge of the claim, no opportunity to investigate or negotiate a settlement, it may be that the decision would be different.

- Tara

Fifth Circuit Agrees: Duty to Indemnify Broader than Duty to Defend Under Texas Law

In D.R. Horton-Texas, Ltd. v. Markel Int’l Ins. Co., 300 S.W. 3d 740 (Tex. 2009) and Burlington Northern & Santa Fe Railway Co. v. Nat'l Union Fire Ins. Co., 334 S.W.3d 217 (Tex. 2010), the Texas Supreme Court established the rule that an insurer can have a duty to indemnify even in the absence of a corresponding duty to defend.  The United States Court of Appeals for the Fifth Circuit recently addressed this concept in Colony Ins. Co. v. Peachtree Construction, Ltd., 2011 U.S. App. LEXIS 14740 (July 19, 2011).

Peachtree was a general contractor hired by the State of Texas for a highway-repaving project.  Peachtree contracted with a third party, CrossRoads, to provide construction signs, barricades and warning devices.  Pursuant to this contract, CrossRoads was required to name Peachtree as an additional insured under its primary and excess liability policies.   Colony was CrossRoads’ primary liability carrier.

Peachtree was later sued in a wrongful death action arising out of a motorcycle crash that happened at the construction site. While the suit alleged that Peachtree failed to use proper signage and warnings, CrossRoads was not named as a defendant nor did it contain any allegations concerning CrossRoad’s negligence.  Peachtree tendered the matter to CrossRoad’s insurers.  Colony provided Peachtree with a defense under a reservation of rights, but commenced a declaratory judgment action, arguing that it had no duty to defend or indemnify since the underlying matter did not allege negligence on the part of CrossRoads. The federal district court granted summary judgment in favor of Colony, holding that because the underlying suit did not allege any negligent arising out of CrossRoads’ work, Colony had no duty to defend Peachtree, and as such, it could not have a duty to defend.

Peachtree did not appeal the aspect of the district court’s concerning the duty to defend.  Rather, its appeal was limited to the issue of whether in light of the D.R. Horton decision (the matter apparently was briefed before the Burlington Northern decision), Colony could have a duty to indemnify even though its defense obligation was not triggered.  The Fifth Circuit, citing to D.R. Horton, agreed that indemnity obligation could arise even in the absence of a defense obligation, explaining that under Texas law, the duty to indemnify is not subordinate to the duty to defend and, in fact, requires a separate factual analysis.  Even though the underlying suit did not contain any allegations concerning CrossRoads’ own negligence that would trigger a defense obligation, the district court was still required to consider whether Colony had a duty to indemnify.  As the Fifth Circuit explained, “[w]here there has been an underlying trial on the issue of liability, the facts adduced at trial might differ from the allegations, and thus, a duty to indemnify could be shown notwithstanding the absence of a duty to defend.”  Thus, the lower court was required to consider any factual evidence offered by Peachtree, including evidence extrinsic to the underlying complaint, to determine whether the accident arose out of CrossRoads’ work performed on behalf of Peachtree such that Colony’s indemnity obligation was triggered.