Connecticut Court Holds Insurer Not Entitled to Recoupment of Defense Costs

In Security Ins. Co. of Hartford v. Lumbermans Mutual Casualty Co., 826 A.2d 107 (Conn. 2003), the Connecticut Supreme Court held that when an insurer “defends the insured against an action that includes claims not even potentially covered by the insurance policy, a court will order reimbursement for the cost of defending the uncovered claims in order to prevent the insured from receiving a windfall.”  The United States District Court for the District of Connecticut recently had occasion to address the bounds of this rule in Nationwide Mutual Ins. Co. v. Mortensen, 2011 U.S. Dist. LEXIS 77356 (D. Conn.  July 18, 2011).

The insureds in Nationwide were former insurance agents for Nationwide and its affiliated companies.  These individuals also happened to be insured by Nationwide under Business Provider Insurance Policies.  In the underlying suits, Nationwide sued the individuals on several grounds, including breach of contract, breach of fiduciary duty, unfair trade practices and trademark infringement.  These individuals, in turn, sought coverage for the underlying suits under their Nationwide policies.  Nationwide agreed to provide a defense subject to a reservation of rights, including the right to seek recovery of defense costs associated with non-covered claims.  It subsequently filed coverage litigation action against the insureds and successfully obtained a declaratory judgment that it had no coverage obligation with respect to the underlying suits.  In a 2009 decision, however, the court held that Nationwide was not entitled to reimbursement of defense costs incurred prior to the declaratory judgment, explaining that:

It was in Nationwide's own interest to provide a defense under the reservation of rights in order to avoid exposure had the Court held it did have a duty to defend. If the Court were to now allow Nationwide to recoup defense costs, the defendants would be required to pay for the action Nationwide took to protect itself. In these circumstances, in the absence of a policy provision pointed to by Nationwide or active assent to the reservation by the defendants, the reservation of rights letters were not enough to impose a burden on the defendants to reimburse Nationwide for defense costs.  Nationwide Mut. Ins. Co. v. Mortensen, 2009 U.S. Dist. LEXIS 74870 at *18-19 (D. Conn. Aug. 24, 2009).

Nationwide subsequently moved for reconsideration, arguing that decision by the Connecticut Supreme Court in Security Ins. Co. established a general rule that an insurer could recover defense costs associated with non-covered claims.  The Nationwide court disagreed with Nationwide, explaining that Security Ins. Co. should be limited to its facts.  The Security Ins. Co. matter concerned an insured’s asbestos liabilities over a seventeen-year period, several years of which it was uninsured.  The Connecticut Supreme Court held that in light of Connecticut’s pro rata methodology for allocating defense costs, the insured should be required to pay its prorated share of the defense for uninsured periods.  As such, the insurers were entitled to reimbursement of defense costs they had already paid for these periods.  The Nationwide court reasoned that recoupment of defense costs was proper in Security Ins. Co., since there was no potential for coverage in the uninsured periods.  By contrast, explained the court, while it was determined that the underlying suits brought by Nationwide were not covered, “there was at least a potential that the defendants’ claims would be covered.”  (Emphasis in original.)   Given this potential, explained the court, “Nationwide had a temporary duty to defend until a determination on coverage was made,” and as such, it would be improper for Nationwide to recoup its defense costs incurred during this period.

Eleventh Circuit Holds Repair of Insured’s Work Not Covered Property Damage

In its recent decision Palm Beach Grading, Inc. v. Nautilus Ins. Co., 2011 U.S. App. LEXIS 14576 (11^th Cir. July 14, 2011), the Eleventh Circuit affirmed a holding by the United States District Court for the Southern District of Florida that costs associated with repair of the insured’s own work does not constitute “property damage” under a general liability policy.

The insured, A-1 Underground, had been subcontracted to construct water utilities and sanitary sewer utilities in connection with a larger construction project.  A-1 later abandoned the project, forcing the general contractor, Palm Beach Grading (“PBG”) to hire a second subcontractor to complete the work.  The second subcontractor determined that A-1’s work associated with a sewer line was defective, requiring the subcontractor to dig up and replace the line.  PBG later sued and obtained a judgment against A-1.  PBG then commenced suit against A-1’s general liability carrier, Nautilus, seeking recovery of the repair costs.

The Eleventh Circuit acknowledged that under Florida law, faulty work can constitute an “occurrence.”  The court nevertheless agreed with the lower court that the repair costs associated with A-1’s faulty work did not constitute third-party property damage as required under the policy.  In so holding, the Eleventh Circuit relied on the decisions by the Florida Supreme Court in U.S. Fire Ins. Co. v. J.S.U.B., Inc., 979 So.2d 871 (Fla. 2007) and Auto-Owners Ins. Co. v. Pozzi Window Co., 984 So.2d 1241 (Fla. 2008), in which the courts concluded that a general liability policy only covers the costs of repairing damage resulting from an insured’s defective work, not the cost of repairing the or removing the defective work itself.  Because PGB’s claim was limited to repairing the sewer line, as opposed to damage caused by the sewer line (such as resulting sinkholes or back-ups), the underlying suit did not allege “property damage” triggering coverage under the Nautilus policy.

Sixth Circuit Holds Supplier is a Subcontractor Under Business Risk Exclusion

In its recent decision Mosser Constr. v. Travelers Indem. Co., 2011 FED App. 0481N (6^th Cir. July 14, 2011), the United States Court of Appeals for the Sixth Circuit, applying Ohio law, had occasion to consider what constitutes a “subcontractor” for the purpose of a “your work” exclusion in a general liability policy. 

The insured, Mosser, was a general contractor hired to construct an addition to a waste water facility plant.  As part of its work, Mosser was required to place structural backfill beneath and around the new building.  The contract specifically required that Mosser use backfill meeting the size and grading requirements for AASHTO #57 coarse aggregate.  Mosser contracted with a supplier for the purchase of the required fill, which the supplier happened to have available in stock. The supplier never visited the construction site and, in fact, was not even involved in the delivery of the fill to the site.  The backfill ultimately proved to be defective, resulting in damage to the newly constructed facility.

Mosser’s general liability carrier, Travelers, denied coverage for the resulting property damage claim made against Mosser based on a standard “your work” exclusion applicable to:

l.          Damage To Your Work

"Property damage" to "your work" arising out of it or any part of it and included in the "products-completed operations hazard".

The exclusion, however, is subject to the following standard exception:

This exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.

Mosser argued that the exception applied to the exclusion since the supplier of the fill should be considered a subcontractor.  Travelers, on the other hand, argued that subcontractor has a well-understood meaning within the construction industry that is typically limited to contractors that actually perform work on a project.  As such, argued Travelers, a supplier of materials to be used in a construction project cannot qualify as a subcontractor.

Noting that no Ohio court had addressed the definition of subcontractor for the purpose of the “your work” exclusion, the Sixth Circuit looked to case law in other jurisdictions.  The court acknowledged that several courts had concluded that a material supplier can qualify as a subcontractor when that supplier fabricates the purchased material to some degree of customization, or otherwise performs some work on site.  In other words, a supplier must do something more than merely provide standard inventory items. 

In light of this case law, the Sixth Circuit concluded that the undefined term “subcontractor” was ambiguous and therefore must be construed in a manner most favorable to Mosser.  The court, however, refused to draw a bright line, as argued by Mosser, that all suppliers of material are necessarily subcontractors.  For example, explained the court, a hardware store selling standard-inventory nails is not a subcontractor.  Rather, when a supplier does not perform any actual work on site, it will be considered a subcontractor only when it “must manufacture the material according to specifications supplied by the general contractor, and, its materials contract with the general contractor must explicitly incorporate terms from the master contract or otherwise explicitly indicate that the materials at issue are manufactured or supplied specifically for the master contract's project.”

Turning to the specific facts in Mosser, the court concluded that while the supplier happened to have the requested fill in stock, such was a mere coincidence and that the supplier would have had to custom fabricate such fill had it not been in stock.  Just as significant for the court was the fact that the purchase order entered into between Mosser and the supplier specifically referenced the underlying general contract for which the fill would be required.  Thus, “[a]lthough [the supplier] may have produced all or part of the backfill before entering into the purchase order with Mosser, the circumstances of this case are enough to nudge [the supplier] over the line separating mere material suppliers from subcontractors.”

While the Mosser court was careful to avoid the bright-line advocated by the insured, i.e., that all suppliers are subcontractors, the court’s decision nevertheless has the potential to have significant insurance coverage ramifications, both in terms of the business-risk exclusions as well as for additional insured issues.

D.C. Court Holds No Prejudice Resulting From Insurer’s Control of Defense

In its recent decision in Capitol Specialty Ins. Corp. v. Sanford Wittels & Heisler, LLP, 2011 U.S. Dist. LEXIS 68171 (D.D.C. June 27, 2011), the United States District Court for the District of Columbia had occasion to consider whether the insurer, as a result of its actions, was estopped from denying coverage to its insured.

The policy at issue in Capitol Specialty was a lawyers’ professional liability policy issued to a firm that was sued for malpractice in connection with its prosecution of a class action.  The insurer, Capitol Specialty, agreed to provide the firm with a defense in the malpractice suit under a reservation of rights.  While the insured initially selected defense counsel of its own choice, Capitol Specialty subsequently exercised its right under the policy to pick counsel.  In doing so, Capitol Specialty specifically advised that if the insured did not want to cede control of the defense, Capitol Specialty would “disengage counsel and close this matter.”  Capitol Specialty’s letter regarding selection of counsel reiterated its earlier reservation of rights.  Nearly seven months later, Capitol Specialty denied coverage for the matter based on the policy’s prior knowledge exclusion.

In a subsequent declaratory judgment action, Capitol Specialty was successful in showing that the exclusion operated to preclude coverage.  The insured, however, argued that Capitol Specialty was estopped from denying coverage after having controlled the defense.  The court noted that while Capitol Specialty did control the insured’s defense, it did so under a proper reservation of rights.  Under the circumstances, explained the court, estoppel will lie only where the insured can show that it was actually prejudiced as a result of the insurer’s conduct.  Such prejudice could be shown by demonstrating that the insurer’s control of the defense harmed or hindered the insured by undermining its ability to defend itself.

The insured argued that Capitol Specialty was estopped from denying coverage because: (1) it initially advised that coverage was available for the underlying suit; (2) it assumed the defense of the underlying suit; (3) it waited too long before disclaiming coverage and (4) it prejudiced the insured’s defense.  The court easily rejected the first three points, explaining that these arguments were “not evidence of prejudice” in light of Capitol Specialty’s proper reservation of rights.  Turning to the fourth point, the court held that the insured failed to demonstrate that it had been actually prejudiced.  While Capitol Specialty did cause the insured to terminate its initial counsel, the court explained that this would be prejudicial only if the insured could demonstrate that counsel selected by the insurer performed demonstrably worse than preferred counsel would have performed.  Because the insured alleged no facts of “poor representation or malpractice” and because the insured never objected to Capitol Specialty’s conditional defense, the court concluded that the insured failed to show that it had been prejudiced.

Michigan Court Holds No Coverage Under Successive UST Policies

In its recent decision Webb Operating Co. v. Zurich American Ins. Co., 2011 U.S. Dist. LEXIS 73675 (E.D.Mich. July 8, 2011), the United States District Court for the Eastern District of Michigan had occasion to consider whether an insured under a series of consecutive claims made and reported underground storage tank policies was entitled to coverage for remediation costs where it failed to report the “claim” during the proper policy period.

The policies at issue insured a gas station operated by the insured for cleanup costs as required by governmental authorities resulting from releases from covered underground storage tanks, but only to the extent discovered during the policy period and only to the extent the “claim” was reported to Zurich during the policy period.  The relevant policy defined “claim” as notice given by the insured, during the “policy period” seeking payment of “cleanup costs” required by a “governmental authority.”  The preamble to the policies expressly identified the policies as “claims made and reported” policies.

During the period the insured’s 2005-2006 policy was in effect, one of its covered underground storage tanks failed a tank tightness test.  The insured subsequently decided to close its tank, but chose not to report the matter to Zurich at the time because the costs associated with the tank closure barely exceeded the policy’s deductible.  The insured, however, continued to incur monitoring and remediation costs over the next three years, ultimately leading to its decision to give notice to Zurich when its policy for the 2009-2010 period was in effect.  The insured argued that coverage should be afforded under the 05-06 policy, or at the very least, under the 09-10 policy, since that was when it gave notice of claim.  Among other things, the insured argued that Zurich could not disclaim coverage under the 05-06 policy unless it could show it had been prejudiced as a result of the insured’s delayed notice.

The court rejected the insured’s prejudice argument, explaining that prejudice is a consideration only with respect to occurrence-based policies, not claims made and reported policies.   Because the Zurich policies were claims made and reported policies, wrote the court, Zurich was not required to show that it was prejudiced under the 05-06 policy in order to disclaim coverage.  Rather, Zurich only needed to show that the insured failed to comply with the policy’s condition precedent to coverage; namely, giving notice of “claim” during the same policy period in which the release was first discovered.  The court concluded for the same reason that coverage was unavailable under the 09-10 policy since the release was not first discovered during the time that policy was in effect.

Insurance Fraud

The front page of the Toronto Star today headlines "Shady clinics bilk $1.3 billion in bogus car insurance claims scam".

The related article states:

Ontario’s car insurance industry is under attack by bogus medical clinics that use fake accident treatment charges to milk the system...

Travel around Toronto and you will see more and more of these rehabilitation clinics popping up. Anybody can open one and they are not regulated. One New York man with an auto insurance fraud conviction is listed as administrator of a Mississauga clinic.

...Here’s how it typically works.

Tow truck drivers or paralegals direct accident victims — drivers and passengers — to rehab clinics. They might get a finder’s fee of $1,000 cash or, in the case of paralegals, a percentage of the payout. It is not uncommon for a clinic to bill an insurer $40,000 over the life of a claim.

The accident victims the Star found often spoke little or no English. At the clinic they were handed forms to sign that gave the clinic the right to submit claims to their insurance firm and receive payments.

Here is a link to the Toronto Star's website.

Deductibility of Statutory Accident Benefits

Sutherland v. Singh, [2011] O.J. No. 2901 (C.A.)

The plaintiff was eligible for income replacement benefits (IRBs) and caregiver benefits (CGBs). He elected to receive CGBs. Under s. 267.8(1) of the Insurance Act, damages are reduced by payments for statutory accident benefits that the plaintiff received or that were “available”. The issue on appeal was whether IRBs were “available” to the plaintiff (thus allowing the tort defendant to deduct them) even though he elected to receive CGBs. The Court of Appeal held that the answer is “no”.

Justice Gillese held that once the plaintiff elected to receive CGBs, IRBs were no longer available to him. The purpose of s. 267.8 is to prevent double recovery. The effect of allowing the defendants to deduct CGBs that the plaintiff received as well as IRBs that he never received would be to create a windfall for the defendant.