Arizona Court Considers Coverage Under An Employment Benefit Endorsement

In its recent decision in Enterprising Solutions, Inc. v. National Union Fire Ins. Co. of Pittsburgh, PA (D. Ariz. Sept. 11, 2012), the United States District Court for the District of Arizona had occasion to consider whether an insured was entitled to coverage under a professional liability policy’s employee benefits liability coverage for its alleged failure to have properly calculated necessary contributions to fund a group medical and dental plan.

The insured, Enterprising Solutions, Inc. (“ESI”) was a professional employer organization, providing outsourced services such as payroll administration to employer-clients.   ESI and its clients would enter into “co-employer agreements” whereby it would assume various employer-related responsibilities.  Through these agreements, ESI became a co-employer of its clients’ employees.  At issue in the Enterprising Solutions litigation was ESI’s administration of an employee health benefit program and an employee dental plan.  Among other things, ESI assumed responsibility for determining the amount of contributions necessary to fund the plans.  The contribution levels established for the 2008 and 2009 plans turned out to be insufficient to cover claims and expenses, causing ESI it to terminate the plans.  As a result, ESI was the subject of numerous claims brought by plan participants.

National Union insured ESI under a Staffing Services Liability Policy, providing professional liability coverage ESI’s employment-related administrative services.  Of relevance, the policy excluded from coverage the “Insured’s failure to fulfill any duty or obligation imposed by Employment Retirement Income Security Act of 1974, including amendments to that law, or similar federal, state, or local statutory or common law.”  Also relevant to the coverage dispute was an Employee Benefit Liability (“EBL”) endorsement, which insured:

… all sums which you shall become legally obligated to pay as damages because of any claim made against you for “wrongful acts” arising out of “administration” of your “employee benefits program,” …

The EBL endorsement defined “administration” as:

(a) giving counsel to employees with respect to your “employee benefits program”;

(b) interpreting your “employee benefits” program”;

(c)  handling of records in connection with your “employee benefits program”; or

(d) effective enrollment, termination or cancellation of “employee” under your “employee benefits programs”

provided any action which gives rise to a “Wrongful Act” was authorized by you.

The EBL endorsement also contained an exclusion barring coverage for “all sums which you shall become legally obligated to pay as a loss because of any ‘breach of fiduciary duty’ or because of any ‘breach of fiduciary duty’ by any person for whom you are legally responsible and arising out of your activities as a fiduciary of any plan covered by this endorsement.”

National Union argued, among other things, that the underlying claims were not covered, as the claims did not result from a “wrongful act” and that in any event, the claims were excluded from coverage as a result of the ERISA exclusion and the breach of fiduciary duty exclusion.   The court agreed, albeit skeptically, that ESI’s alleged conduct constituted “wrongful acts” as that term was defined.  It nevertheless concluded that exclusions barred coverage for the conduct alleged.  Specifically, the court held that ESI’s responsibilities in determining the level of necessary contributions did not fall within the policy’s definition of “administration,” reasoning that it could find no authority for the proposition that “discretionary decision-making activities,” such as determining contributions, qualify as “administration” of an employee benefit plan.  The court further noted that:

Plaintiff's calculation of contribution levels involved the exercise of discretion and was not, therefore, merely administrative. In that respect, plaintiff's exercise of discretion in failing to properly calculate contributions is not included within the definition of "administration" and is beyond the scope of the policy.

The court also concluded that even if ESI’s miscalculation of contributions could be considered “administration” of an employee benefits program, the miscalculation was still undertaken in ESI’s fiduciary capacity to the plan participants.  “Fiduciary,” the court observed, is defined by ERISA as:

[A] person is a fiduciary with respect to a plan to the extent (I) he exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets; (ii) he renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or (iii) he has any discretionary authority or discretionary responsibility in the administration of the plan.

The court concluded that ESI qualified as a fiduciary as it had “control and authority” over the health and dental plans.  Specifically, the court found that ESI’s miscalculation of necessary contributions “was, indeed, the exercise of discretion relating to plan management and administration and was, consequently, subject to ERISA fiduciary standards.”  As such, the court concluded that the policy’s ERISA and breach of fiduciary duties exclusions served as additional grounds for noncoverage.

Massachusetts Court Holds No Coverage for Withheld Employee Tips

In its recent decision in Berkshire-Cranwell Limited Partnership v. Tokio Marine & Nichido Fire Ins. Co., 2012 U.S. Dist. LEXIS 93635 (D. Mass. July 6, 2012), the United States District Court for the District of Massachusetts had occasion to consider whether claims brought by the insured’s employees for wrongful withholding of tips triggered coverage under general liability and/or employee benefit liability policies.

The insured, Cranwell Resort, is a resort spa in Lenox, Massachusetts.  It charged “service fees” at its restaurants and spa, but it was alleged that these service fees were not distributed to the employees that actually performed the services.  Cranwell was named as a defendant in two separate class actions lawsuits brought by employees alleging violations of Massachusetts Tips Act and Massachusetts’ Wage Act, as well as causes of action for breach of contract, conversion, and breach of the implied covenant of good faith and fair dealing.  For reasons not even clear to the court, Cranwell did not give notice of the suits to its insurers until almost three and a half years after the suits were filed.  Cranwell had two potentially responsive policies: both general liability policies with employee benefit liability (“EBL”) extensions.  Both insurers denied coverage on the basis that the claims were not covered, and that in any event, Cranwell failed to give timely notice of the suits.

In considering coverage under the policies’ general liability coverage, the court identified the key issue as whether the suits qualified as claims for “property damage,” defined in pertinent part as loss of use of tangible property.  The court observed that some courts, such as those in Nevada and Arkansas, have considered cash to constitute tangible property.  The court further noted, however, that in each of these cases, it was “conversion of actual paper currency.”  For instance, in Capitol Indem. Corp. v. Wright, 341 F.Supp.2d 1152 (D.Nev. 2004), when an employee of a group home instructed a resident with Alzheimers’s disease to withdraw money from an ATM, the court concluded that the converted funds constituted tangible property.  Likewise, in Hortica-Florists’ Mut. Ins. Co. v. Pittman Nursery Corp., 2010 WL 749368  (W.D.Ark. Mar 2, 2010), where a company manager required each employee to pay him $1,000 to retain their jobs, the court held that the payments constituted tangible property.

The court noted that the distinction between the facts involving Cranwell and those in Wright or Pittman was that the monies involved in latter cases were “misappropriated as a physical object.”  Such was distinguishable from cases involving conversion of “non-currency monies,” such as wages.  The court explained this difference:

When the Black and Wechter plaintiffs alleged that their tips, characterized as service fees were wrongfully converted, they were clearly alleging that Plaintiff took their money for its exchange value and not in the form of some physical object or objects.  There was, with perhaps an occasional exception, no physical handover of tangible currency from the employees to Plaintiff.  Instead, Plaintiff simply retained the service fees, diverting them into its general account.  In this circumstance, no “tangible property” was involved, no duty to defend arises, and no coverage adheres.

In reaching this conclusion, the court considered and rejected Cranwell’s argument that in some instances, guests at the resort paid the service fees in cash, and that in some instances, this cash was paid directly to the employees before being diverted to Cranwell’s general account.  The court concluded that there was no allegation that the service fee payments were ever “in the hands” of the plaintiff employees. The court further hel that the decisions in Wright and Pittman, relied on by Cranwell, were not controlling on a Massachusetts court, and strongly suggested that their reasoning was improper.

Having determined that the underlying suits did not allege “property damage,” the court considered Cranwell’s argument that the suits triggered its employee benefits liability coverage.  The court noted that while Cranwell’s two EBL policies contained slightly different definitions of “employee benefits,” both pertained to “fringe benefits,” such as health insurance or retirement plans.  Applying the principle of ejusdem generis, the court concluded that “a reasonable insured would find the list of fringe benefits under the definition of ‘employee benefits’ to be inclusive of only traditional health, welfare and retirement benefits, and exclusive of wages such as cash tips.” 

Finally, while not necessary to the court’s decision in light of its other findings, the court held that Cranwell’s delay in giving notice to its insurers vitiated its right to coverage.  During the three and a half year delay, the classes were certified in the two lawsuits, several motions and cross motions for summary judgment were made, and Cranwell had begun settlement discussions with underlying plaintiffs.  Under the circumstances, the court concluded that Cranwell’s insurers suffered “substantial prejudice,” as required by Massachusetts law.  As the court concluded, “the transit of both lawsuits was all but over before Defendants even learned of them.  In such a situation, it would be unfair to expect Defendants to step in at the last minute to shoulder settlement and defense costs without any opportunity to shape the course of litigation.”