Category: Insurance Coverage

The New Wave of Insurance Construction Defects? Four States Enact Statutes Favoring Coverage for Faulty Workmanship

Recently posted in the National Law Review an article by Clifford J. Shapiro and Kenneth M. Gorenberg of Barnes & Thornburg LLP about whether construction defects are covered by commercial general liability (“CGL”) insurance policies and briefly discuss four new statutes in various states.

 

 

Courts across the country remain split on the issue of whether claims alleging construction defects are covered by commercial general liability (“CGL”) insurance policies. The primary battle ground has been whether such claims involve an accidental “occurrence” within the meaning of the CGL policy coverage grant. Now this issue is getting substantial attention from state legislatures. Four states recently enacted new legislation addressing insurance coverage for construction defect claims, and each statute favors coverage,albeit in different ways and to varying degrees. These statutes signal that the battle over whether construction defects constitute an “occurrence” may have shifted from the courts to state legislatures. The four new statutes are discussed briefly below.

Colorado

Section 13-20-808 of the Colorado Code, effective May 21, 2010, creates a presumption that a construction defect is an accident, and therefore an “occurrence” within the meaning of the standard CGL insurance policy. To rebut this statutory presumption, an insurer must demonstrate by a preponderance of the evidence that the property damage at issue was intended and expected by the insured. The statute expressly does not require coverage for damage to an insured’s own work unless otherwise provided in the policy, leaving that potentially to be decided by Colorado’s courts. In addition, the act does not address or change any policy exclusions, the scope of which will also remain an issue possibly to be determined in court. Thus, it appears that the Colorado statute resolves in favor of coverage that construction defect claims give rise to an accidental “occurrence” under the CGL policy coverage grant, but leaves most other insurance issues affecting coverage in the construction defect context subject to further attention by the courts.

Hawaii

Chapter 431, Article 1 of the Hawaii Revised Statutes provides that “the term ‘occurrence’ shall be construed in accordance with the law as it existed at the time that the insurance policy was issued.” The statute does not declare what the “the law” is now or what “the law” was at any time in the past. However, the preamble explains that the appellate court decision in Group Builders, Inc. v. Admiral Ins. Co., 231 P.3d 67 (Hawaii 2010) “invalidates insurance coverage that was understood to exist and that was already paid for by construction professionals,” and that the purpose of the statute is to restore the coverage that was denied. While not necessarily clear from the appellate court decision, coverage arguably was denied for both defects in the insured’s own work and also consequential property damage caused by faulty workmanship.

Thus, it appears that the legislature’s intent was to allow insurers to deny coverage under policies issued after May 19, 2010 to the extent permitted by the courts based on Group Builders and whatever further judicial decisions may follow, but to require application of the more favorable judicial interpretations of coverage for construction defects that the Hawaii legislature believes existed before that time. In other words, the Hawaii statute appears to be an attempt to preserve more favorable treatment of coverage for construction defect claims for projects currently underway which were insured under policies issued before Group Builders was decided.

This approach, of course, still leaves it to the courts to interpret the applicable law with respect to any particular claim (i.e., the law that existed at the time the policy was issued). But we cannot help but think that the Hawaii courts may be influenced going forward to find more readily in favor of coverage due, at least in part, to the part of the preamble to the legislation that states: “Prior to the Group Builders decision … construction professionals entered into and paid for insurance contracts under the reasonable, good-faith understanding that bodily injury and property damage resulting from construction defects would be covered under the insurance policy. It was on that premise that general liability insurance was purchased.”

Arkansas

Arkansas Code Section 23-79-155 (enacted on March 23, 2011) requires CGL policies offered for sale in Arkansas to contain a definition of occurrence that includes “property damage or bodily injury resulting from faulty workmanship.”It is unclear whether this requirement applies to policies previously issued. The act also states that it does not limit the nature or types of exclusions that an insurer may include in a CGL policy. Thus, the numerous exclusions related to construction defect claims contained in the typical CGL insurance policy are not affected by the Arkansas statute, and the judicial decisions that have interpreted those exclusions presumably remain good law.

South Carolina

Enacted on May 17, 2011, South Carolina Code Section 38-61-70 provides that CGL policies shall contain or be deemed to contain a definition of occurrence that includes property damage or bodily injury resulting from faulty workmanship, exclusive of the faulty workmanship itself. However, whether the South Carolina statute will change the law in South Carolina is unclear because the statute was immediately challenged in court. On May 23, 2011, Harleysville Mutual Insurance Company filed a complaint in the South Carolina Supreme Court seeking injunctive relief and a declaration that the new statute violates several provisions of the U.S. and South Carolina constitutions, particularly with respect to existing insurance policies at issue in pending litigation.

Conclusion

The new state statutes are intended to overrule, at least to some extent, judicial decisions that denied insurance coverage for construction defect claims. The thrust of these statues is to require construction defects to be treated as an accidental “occurrence” within the meaning of the CGL insurance policy. As such, the legislation generally should make it easier for policyholders in the affected states to establish at least the existence of potential coverage for a construction defect claim, and thereby more easily trigger the insurance company’s duty to provide a defense. Whether these statutes will also result in increased indemnity coverage for construction defect claims, however, remains to be seen. Among other things, the statutes generally do not alter the exclusions that already apply to construction defect claims, and they leave the interpretation of the meaning of these exclusions to the courts.

In short, while this new wave of statutes increases the complexity and divergence among the states of this already fractured area of the law, they also appear to increase the likelihood of insurance coverage for construction defect claims in Colorado, Hawaii, Arkansas and South Carolina.

© 2011 BARNES & THORNBURG LLP

Evaluating Insurance Policies After Japan’s Earthquake

Posted on July 14, 2011 in the National Law Review by Risk Management Magazine of Risk and Insurance Management Society, Inc. (RIMS) information about an essential first step is to review insurance coverages for losses caused by natural catastrophes.

Shock and tragedy were the emotions most felt throughout Japan when the March earthquake and tsunami ravaged the nation. But companies doing business there have since moved on to planning mode, looking for ways to mitigate their losses, both those already suffered and the inevitable ones to come from similar exposures in the future.

An essential first step is to review insurance coverages for losses caused by natural catastrophes. Of particular importance is the potential availability ofcontingent business interruption insurance coverage for lost sales to Japanese customers or lost supplies from Japanese producers.

Property insurance policies obviously cover direct property damage caused by natural disasters. But those same policies also cover other types of business losses. Time element coverage pays for the lost profits when damaged property affects a policyholder’s day-to-day operations. The amount covered generally depends on the time it takes to resume normal business operations. Time element coverage can be triggered by damage either to the policyholder’s property or a third party’s property, and the most common kinds are business interruption, extra expense and contingent business interruption.

Business Interruption

The purpose of business interruption coverage is to restore the policyholder to the financial position it was in before the property damage occurred. To recover these losses, the lost profits, at a minimum, must relate to the event that caused the policyholder’s property damage. Once the insured demonstrates covered property damage, the measure of the loss generally is the difference between expected profits during the recovery period after the event and actual profits during that period, less any unrelated losses.

Perhaps the only recent U.S. event comparable to Japan’s earthquake is Hurricane Katrina. In Consolidated Cos. v. Lexington Ins. Co., the Fifth Circuit Court of Appeals ruled that business interruption losses resulting from Hurricane Katrina were covered without requiring proof to a level of specificity that the loss stemmed solely from damage to the policyholder’s property as a result of the hurricane. The insurance carrier argued that the policyholder had to prove what its likely performance would have been had Katrina taken place but not damaged the policyholder’s property, reasoning that, even absent damage to the policyholder’s property, profits would have been reduced because of the generally depressed economic conditions following the hurricane. Instead, the court concluded that the loss should be calculated as if Katrina had not struck at all.

Coverage for this interdependent business interruption loss can extend to locations that are distant from the damaged property if the policyholder can show that the undamaged facility operated in concert with the damaged one. An example would be a policyholder’s remote facility outside of Japan that cannot receive inventory because of damage to the policyholder’s manufacturing plant in Japan.

Extra Expense

Extra expense coverage aims to cover additional costs the policyholder incurs to minimize or avoid interruption of its business. Examples of such coverage are: additional utility costs needed to resume business operations; additional costs to store business equipment; moving costs to relocate to temporary facilities; and costs expended for the temporary repair or replacement of property. Most policies also contain a related coverage, similar to extra expense, typically called expense to reduce loss coverage, to reimburse additional costs incurred to mitigate property damage.

Contingent Business Interruption

Many policies protect against profits lost when a policyholder’s supplier or customer cannot conduct business because of property damage “of the type” covered under the policyholder’s policy. This coverage would provide, for example, recovery to a manufacturer of computers outside of Japan that suffers lost profits as a result of a supplier’s inability to provide required components because of damage to the supplier’s Japanese facility. Similarly, a policyholders’ profits affected by property damage to the facilities of a Japanese customer are recoverable. Covered costs also include losses incurred when a civil authority prevents access to the policyholder’s facilities, or when damage to property in the vicinity of the insured property prevents ingress to, or egress from, the policyholder’s facility.

John Banister, Erica Dominitz, Barry Fleishman, Helen Michael, Carl Salisbury and Caroline Spangenberg are all partners at Kilpatrick Townsend & Stockton.

Risk Management Magazine and Risk Management Monitor.  Copyright 2011 Risk and Insurance Management Society, Inc. All rights reserved.

Don't Gamble with My Money: When a Lawsuit Seeks Damages in Excess of Policy Limits, What Are the Insured's Rights in Illinois?

Posted this week at the National Law Review by Daniel J. Struck and Neil B. Posner of Much Shelist Denenberg Ament & Rubenstein P.C.  a good overview of R.C. Wegman Construction Company v. Admiral Insurance Company which help address the issues involved with insurance claims in excess of policy limits in Illinois: 

In general, if a lawsuit is covered or potentially covered by a commercial general liability (CGL) insurance policy, the insurer has a duty to defend that claim. If the insurer provides that defense without reserving its rights to deny coverage, the insurer is entitled to select defense counsel and control the defense. But when the insurer defends under a reservation of rights, that reservation may create a conflict of interest between the insurer and the insured.

The leading Illinois Supreme Court case on this subject is Maryland Casualty v. Peppers, decided in 1976. According to Peppers, when an insurer defends an insured, but reserves the right to deny coverage based on an exclusion in the insurance policy (the applicability of which could be established during the course of defending the insured), there is a conflict of interest that gives the insured the right to select independent counsel to defend it at the insurer’s expense. But the Illinois Supreme Court did not say that this is the only conflict of interest that could give rise to the insured’s right to select independent defense counsel.

In R.C. Wegman Construction Company v. Admiral Insurance Company, decided in 2011, the United States Court of Appeals for the Seventh Circuit answered a question that has vexed Illinois insureds for a long time. Although the case involves a relatively uncommon set of facts, the court’s ruling in Wegman recognizes the conflicting interests that can arise between insureds and insurers when an insured faces a claim in which there is a “non-trivial probability” that there could be a judgment in excess of policy limits.

The Nuts and Bolts of Wegman

R.C. Wegman Construction Company was the manager of a construction site at which another contractor’s employee was seriously injured. Wegman was an additional insured under a policy issued by Admiral Insurance to the other contractor. When the worker sued Wegman, Admiral acknowledged its duty to defend, apparently without reserving any rights, and undertook the control of Wegman’s defense. The Admiral policy provided $1 million in per-occurrence limits of liability. Although it soon became clear that there was a “realistic possibility” that the underlying lawsuit would result in a settlement or judgment in excess of the policy limits, Admiral never provided this information to Wegman.

Shortly before trial, a Wegman executive was chatting about the case with a relative who happened to be an attorney. That relative pointed out the risk of liability in excess of policy limits, and mentioned that it was important for Wegman to notify its excess insurers. But by then it was too late, and the excess insurer denied coverage because notice was untimely. A judgment was entered against Wegman for more than $2 million. Wegman sued Admiral for failing to give sufficient warning of the possibility of an excess judgment so that Wegman could give timely notice to its excess insurer. According to the Seventh Circuit, the key issue was whether this situation—in which there was a risk of judgment in excess of the limit of liability, and where the insurer was paying for and controlling the defense—gave rise to a conflict of interest.

Admiral’s explanation for failing to inform Wegman was ultimately part of its downfall. Because there were other defendants in the underlying lawsuit, there was a good chance that Wegman would not be held jointly liable and that if a jury determined that Wegman was no more than 25% responsible for the worker’s injury, Wegman’s liability would have been capped at 25% of the judgment. Admiral’s trial strategy was not to deny liability, but to downplay Wegman’s responsibility. Admiral, however, never mentioned this litigation gambit to Wegman!

In the Seventh Circuit’s view, this was a textbook example of “gambling with an insured’s money.” And that is a breach of an insurer’s fiduciary duty to its insured.

When a potential conflict of interest arises, the insurer has a duty to notify the insured, regardless of whether the potential conflict relates to a basis for denying coverage, a reservation of rights, or a disconnect between the available limits of coverage and the insured’s potential liability. Once the insured has been informed of the conflict of interest, the insured has the option of hiring a new lawyer whose loyalty will be exclusively to the insured. In reaching its Wegman conclusion, the Seventh Circuit cited the conflict-of-interest rule established by the Illinois Supreme Court’s Peppersdecision. Thus, a potential conflict of interest between an insured and an insurer concerning the conduct of defense is not limited to situations in which the insurer has reserved its rights.

In rejecting Admiral’s arguments, the Seventh Circuit explained that a conflict of interest (1) can arise in any number of situations and (2) does not necessarily mean that the conflicted party—the insurer—has engaged in actual harmful conduct. A conflict of interest that permits an insured to select independent counsel occurs whenever the interests of the insured and the insurer are divergent, which creates a potential for harmful conduct.

The conflict between Admiral and Wegman arose when Admiral learned that a judgment in excess of policy limits was a “non-trivial probability.” When confronted with a conflict of this type, the insurer must inform the insured as soon as possible in order to allow the insured to give timely notice to excess insurers, and to allow the insured to make an informed decision as to whether to select its own counsel or to continue with the defense provided by the insurer.

Looking Beyond Wegman

The fact pattern discussed in Wegman, however, is not the only situation in which there may be a conflict of interest between an insurer and an insured concerning the control of the defense. Under the supplemental duty to defend in a CGL policy, an insured is entitled to be defended until settlements or judgments have been paid out in an amount that equals or exceeds the limits of liability. The cost of defense does not erode the limits of liability, which means that the supplemental duty to defend is of significant economic value to an insured.

The following hypothetical situations (involving an insured covered by a CGL policy with $1 million in per-occurrence and aggregate limits of liability and a supplemental duty to defend) illustrate the economic value of the duty to defend:

  • The insured is sued 25 times in one policy year. In each instance, the insurer acknowledges coverage and undertakes to defend the lawsuits. Each lawsuit is dismissed without the insured becoming liable for any settlements or judgments. The total cost of defending these 25 lawsuits is $1.5 million. The limits of liability are completely unimpaired with $1 million in limits of coverage remaining available.
  • The insured is a defendant in dozens of lawsuits alleging that one of the products it sells has a defect that has caused bodily injury. The insurer agrees to defend. The lawsuits are consolidated, and the costs of defense accumulate to more than $2.5 million. Eventually, there is a global settlement of the lawsuits for $1 million. Thus, a total of $3.5 million has been paid out on an insurance policy with a $1 million limit of liability.
  • The insured is involved in a catastrophic accident for which he was solely responsible and in which four other people were permanently disabled. Each of the victims files a lawsuit and the realistic projected liability exposure to each victim is $1.5 million—or $6 million collectively. Shortly after the complaints are filed (and before there has been any significant discovery or investigation), three of the plaintiffs make a joint offer to settle their claims for a collective $1 million. The insurer and the insured both believe that this is an outstanding settlement opportunity, but the fourth plaintiff wants her day in court. If the insured agrees to this promising settlement opportunity, the limits of liability will be exhausted, the duty to defend will be extinguished, and the insured will be forced to pay for his own defense or rely on his excess insurance to reimburse him for defense costs.

Any insured who has been in the position of defending against either a serious claim or a multitude of smaller claims will understand that the supplemental duty to defend under a CGL policy may have much greater economic value than the limit of liability alone.

In these kinds of situations—when either the potential liability exceeds policy limits or there are multiple claims against the insured such that the economic value of the defense is worth more than the limit of liability—who should be allowed to control the defense of claims against the insured? In prior cases (Conway v. County Casualty Insurance Company [1992] and American Service Insurance Company v. China Ocean Shipping Co. [2010]), Illinois courts concluded that an insurer cannot be excused of any further duty to defend by paying out its remaining limits to the plaintiffs or by depositing its policy limits into court. But this rule does not address the conflict of interest when (1) it is in the insurer’s financial interest to avoid the potentially unlimited expense of defending its insured but (2) it is in the insured’s interest to continue receiving a defense that may have greater financial value than the limits of liability of a primary CGL policy.

Thanks to the Wegman decision, there is now some authority acknowledging that the insured’s right to select independent counsel may exist even if the insurer defends without a reservation of rights. The court recognized that the insurer-insured relationship and the right to control the defense is fraught with potential conflicts. Therefore, it is more important than ever for insureds to protect their interests.

Editor’s note: For more on the insured’s right to a defense, see “Policyholders and the Right to a Defense: Don’t Be Left Holding the Bag.”

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.

 

6th Anti-Corruption and FCPA Compliance Conference Set for June 22-24, 2011 in Washington, DC

The National Law Review wants to bring your attention to the following upcoming event(s): 

Building on our past successful FCPA conference series, marcus evans invites you to attend the 6th Anti-Corruption & FCPA Compliance Conference in Washington, DC, June 22-24, 2011, co-located with the Life Sciences Strategies for Anti-Corruption and Compliance Conference.  The event will bring together Government officials and industry leaders in FCPA, Anti-Corruption and Compliance to share best practices, strategies and tools on executing, monitoring and auditing a strong and effective anti-corruption / FCPA compliance program.

Now more than ever organizations need to pay close attention to their anti-corruption compliance programs and ensure robust internalcontrols are in place especially in countries with high corruption to ensure their business transactions are compliant with the FCPA as well as  global anti-corruption laws.

Hear From Leading FCPA Compliance and Anti-Corruption Experts Including:

Jay G. Martin, Vice President, Chief Compliance Officer, Senior Deputy General Counsel, Baker Hughes

C. David Morris, Senior Counsel International, Northrop Grumman Corporation

Melissa Chia, Executive Director, Morgan Stanley Investment Management

Debra Kuper, Vice President, General Counsel and Secretary, AGCO

Stephen Donovan, Chief Counsel, Global Compliance, International Paper Company

Why You Should Attend

1. Learn how to embrace a global anti-corruption compliance program
2. Analyze recent regulatory updates and proposals
3. Understand best practices in effective due diligence and management of third parties
4. Discover ways to monitor and disclose FCPA violations
5. Gain insights on how to tackle upcoming regulatory changes and how to best implement updated policies and procedures into your organization
6. Identify possible violations by examining recent enforcement against companies for committing corrupt practices

With a one-track focus, the 6th Anti-Corruption & FCPA Compliance Conference is a highly intensive, content-driven event that includes case studies, presentations and panel discussions over two full days. This conference targets industry leaders from a variety of top industries in order to provide an intimate atmosphere for both the delegates and speakers.

This is not a trade show; our FCPA conference series is targeted at a focused group of senior level executives to maintain an intimate atmosphere for the delegates and speakers. Since we are not a vendor driven conference, the higher level focus allows delegates to network with their industry peers.

marcus evans has requested CLE accreditation from all appropriate states. marcus evans certifies that this conference has been pre approved for CLE credits by the Pennsylvania, California and West Virginia State continuining legal education authorities and also approved for New Jersey and Colorado CLE credit via reciprocity.

 For more information on this conference or to get a complete list of speakers, sessions or past attendees, visit http://www.marcusevansch.com/NLR_FCPA.

A Primer on the Validity and Effect of Waiver of Subrogation Clauses

Recently posted by Daniel R. Bedell of Johnson & Bell Ltd.  a great overview of subrogation clauses which are included in many contracts.

Waiver of Subrogation Clauses: An Overview

Pursuant to typical “waiver of subrogation” clauses, the parties to a contract will agree to waive any rights of recovery against each other if the damage is covered by insurance. Thus, the risk of loss gets shifted to the insurer.

Courts almost always hold that waiver of subrogation clauses are valid because they advance several important social goals, such as encouraging parties to anticipate risks and procure insurance covering those risks, thereby avoiding future litigation. Waiver of subrogation clauses have been validated even in the face of anti-indemnity, anti-exculpatory and anti-subrogation statutes. See Best Friends Pet Care, Inc. v. Design Learned, Inc., 77 Conn. App. 167, 823 A.2d 329 (2003); May Dept. Store v. Center Developers, Inc., 266 Ga. 806, 471 S.E.2d 194 (1996); 747 Third Ave. Corp. v. Killarney, 225 A.D.2d 375, 639 N.Y.S.2d 32 (1st Dep’t 1996). These courts held that waiver of subrogation clauses are not intended to relieve a party of liability for its own negligence, but are instead risk allocation clauses. Thus, the clauses did not violate the relevant statutes.

Illinois Law on Waiver of Subrogation Clauses

There is relatively little case law in Illinois regarding waivers of subrogation clauses. Although the case is over twelve years old, Intergovernmental Risk Management v. O’Donnell, Wicklund, Pigozzi & Peterson Architects, 295 Ill.App. 3d, 692 N.E.2d 739 (1st Dist. 1998) (“IRM”) remains the premier case in Illinois with regard to waiver of subrogation issues. In that case, the Village of Bartlett (“the Village”) was in the process of expanding its village hall (“the project”). Part of the project entailed constructing a new police station adjacent to the updated village hall. The Village contracted with Defendant O’Donnell, Wicklund, Pigozzi & Peterson Architects (“O’Donnell”) to provide architectural drawings and specification for the project. Pursuant to the contract, the Village purchased insurance from Travelers Insurance Co. through the IRM program. On January 28, 1994, a fire occurred at the newly constructed police station, which caused over $114,000 worth of damage. IRM and Travelers paid the Village that amount pursuant to their policies. IRM and Travelers then filed a subrogation action against O’Donnell, claiming that O’Donnell’s negligence caused the fire and sought reimbursement of the monies paid to the Village pursuant to the insurance policies.

In its motion to dismiss, O’Donnell argued that the plaintiffs’ claims were barred because the Village had waived its subrogation rights in the contracts for the project. The Owner-Architect Agreement between the Village and O’Donnell contained the following waiver of subrogation clause:

“The Owner and Architect waive all rights against each other and against the contractors, consultants, agents and employees of the other for damages, but only to the extent covered by property insurance during construction.”

The plaintiffs argued, inter alia, that the waiver of subrogation provisions could not apply to damage caused by the negligent and wrongful acts of the defendant. The plaintiffs contended that the waiver of subrogation clauses violated public policy by encouraging negligence. However, the court disagreed. It stated that “the purpose of waiver of subrogation provisions is to allow the parties to a construction contract to exculpate each other from personal liability in the event of property loss or damage to the work to the extent each party is covered by insurance.” IRM. at 792. The court noted that waiver of subrogation clause “shifts the risk of loss to the insurance company regardless of which party is at fault.” Thus, it did not matter whether the fire loss was caused by O’Donnell’s negligence so long as the loss was a covered loss that occurred during construction. Id. at 793.

The plaintiffs also argued that the waiver provisions violated of public policy in that they act as indemnity agreements holding the defendant harmless from its own negligence. The court rejected that argument as well. It noted that the waiver provisions do not involve injury suffered by a construction worker or a member of the general public but instead, damage suffered by one of the contracting parties due to the alleged negligence of another. Id. Thus, waiver of subrogation clauses do not violate the public policy considerations which outlaw indemnity agreements. Instead, they merely limit the parties’ recovery to loss sustained to the parties to the agreement and only to the extent that it was covered by insurance. Id. at 794.

The IRM court held that the waiver of subrogation clause was perfectly valid and that it applied to the insurers’ claims. Thus, the plaintiffs’ claims were barred and they could not recover the amounts that they paid to the Village. As mentioned above, IRM is still the preeminent case in Illinois with regard to the validity and effect of waivers of subrogation clauses. Insurers need to be mindful of the effect that such clauses may have on their rights.

Conclusion

Although courts nationwide consider waiver of subrogation clauses to be valid, there are circumstances under which these clauses will not be enforced. For example, in order to establish a waiver of subrogation, it is necessary to show by clear evidence an intentional relinquishment of the right. Thus, if the waiver of subrogation clause is ambiguous or confusing, if the clause conflicts with other contract provisions, or if the intention of the parties is not clear, then courts will not enforce it. See Sutton Hill Associates v. Landes, 775 F. Supp. 682 (S.D. N.Y. 1991); U.S. Fidelity and Guar. Co. v. Friedman, 540 So. 2d 160 (Fla. Dist. Ct. App. 4th Dist. 1989); Charter Oak Fire Ins. Co. v. National Wholesale Liquidators of Lodi, Inc., 2002 WL 519738 (S.D. N.Y. 2002) (applying New Jersey law).

Additionally, courts will not enforce waiver of subrogation clauses where the underlying insurance did not cover the loss at issue. See Gap, Inc. v. Red Apple Companies, Inc., 282 A.D.2d 119, 725 N.Y.S.2d 312 (1st Dep’t 2001);Chelm Management Co. v. Wieland-Davco Corp., 23 Fed. Appx. 430 (6th Cir. 2001) (applying Ohio law). This is of particular importance, as an insurer can craft a condition to coverage that protects its own subrogation rights. As indicated, it is common for insureds to include waiver of subrogation clauses in their contracts with other companies during the course of their business. Waivers under those circumstances will generally take place pre-loss. While these pre-loss waivers may be acceptable, it is important for insurers to make sure the insured does not do anything after a loss which would prejudice the insurer’s right to subrogation. A common condition to coverage that protects an insurer’s subrogation rights will read as follows:

“If the insured has rights to recover all or part of any payment we have made under this policy, those rights are transferred to us. The insured must do everything necessary to secure our rights and must do nothing after the loss to impair them.”

A condition like the one above added into the insurance contract will protect an insurer’s right to subrogation in the event that the insured, after a loss occurs, attempts to enter into an exculpatory agreement that includes a waiver of subrogation clause. While there is little an insurer can do about a pre-loss waiver of subrogation clause (aside from the defenses to enforcement discussed above), a provision similar to the one above will at least protect the insurer from post-loss waivers.

©2011 Johnson & Bell, Ltd. All Rights Reserved.

Risk and Insurance Management Society – RIMS 2011 Annual Conference May 1-5 Vancouver, BC

FYI from the National Law Review — RIMS Risk and Insurance Management Society’s  2011 Annual Conference & Exhibition will gather risk professionals from around the world for a common purpose: to share experiences and gain expertise. Be a part of this community and connect with colleagues, build new relationships and learn from industry experts.

The RIMS Conference & Exhibition takes place at the Vancouver Convention Centre West in Vancouver, BC – May 1-5.

View the online program or just the session descriptions.

Online registration closes April 1st–REGISTER NOW & Save Big over On-Site Registration

Not Your Father's Insurance Coverage: Using Transactional Insurance to Drive Business Opportunities

Posted at the National Law Review last week by Daniel J. Struck and Neil B. Posner of Much Shelist – a review of different type of insurance products that can be helpful in facilitating certain types of financial transactions: 

Insurance coverage as a commercial risk management tool has been around for centuries, but there are a number of newer transactional insurance products that can actually help drive business opportunities and close deals. Developed in the last decade or so and becoming more widely available, these products—including representations and warranties (R&W), tax liability, litigation liability and environmental stop-loss insurance—are decidedly not your father’s insurance coverage. Rather, these less traditional types of coverage can help facilitate the purchase or sale of a business or a significant business asset by reducing the uncertainties associated with potential indemnification obligations and liability exposures.

Traditional Insurance Coverage: Still an Important Corporate Asset

For many businesses, standard commercial insurance is treated as a routine expense in which premiums are the deciding factor in evaluating largely interchangeable form policies. In previous articles, we have discussed why this approach is often short-sighted.

The types of insurance coverage purchased by most businesses are predictable. General liability insurance protecting against liabilities owed to third parties resulting from bodily injury, personal injury and property damage is a given. Some kind of first-party property coverage for loss to owned or rented premises, damage to inventory and equipment, and resulting business interruptions also is generally necessary. Because most businesses have employees, insurance related to workers’ compensation and employee benefits programs is essential. Depending on the particular business, additional lines of insurance—such as management liability, employee dishonesty/fidelity, fiduciary liability, cyber-liability and professional liability—may be necessary as well.

For all their differences, these types of coverage all serve as a means to manage risk and reduce the exposure to potential “fortuitous” first-party losses or third-party liabilities, ranging from slip-and-fall accidents at a retail location to a devastating explosion at a factory or an alleged breach of duty by a company’s directors. Although traditional insurance coverage may help protect the financial health and solvency of a business and its individual partners, officers or directors, it does not often operate as an actual driver of business opportunities.

Transactional Insurance: A Tool for Facilitating Corporate Transactions

Transactional insurance policies, on the other hand, generally insure against risks that fall outside the scope of more traditional coverage and have the potential to drive, or at least facilitate, certain corporate transactions. Examples include:

  • R&W insurance, which provides coverage for the contractual indemnification obligations resulting from breaches of the representations and warranties of a specific agreement (often a contract for the purchase/sale of a business or a significant corporate asset);
  • Tax liability insurance, which provides coverage for an identified potential tax liability or penalty, or for the liability resulting from an adverse determination in a specified ongoing tax dispute;
  • Litigation liability insurance, which may provide coverage if an award of damages in an identified piece of litigation exceeds a threshold specified in the insurance policy; and 
  • Environmental stop-loss insurance, which may provide coverage for the costs of an ongoing environmental remediation project that exceeds a specific cost threshold.

Although commercial insurance policies of every type should be tailored to the particular needs of the insured, the levels of detail and specific underwriting and negotiation involved in placing transactional insurance are generally even greater. For example, the process tends to be fact specific and often involves extensive manuscripting (i.e., the negotiation of customized coverage terms applicable to the specific risks insured against).

But how can transactional insurance facilitate the completion of corporate transactions? Even in the best of times, potential buyers and sellers may find it difficult to agree on price. In the current economic environment, however, distressed sellers may be reluctant to discount the value of their businesses in hopes of a return to better days, while value-conscious purchasers are determined to buy at a substantial discount. Assuming that agreement can be reached on price, the parties must still negotiate the representations and warranties provided by both the buyer and the seller, and then reach acceptable indemnity terms for breaches of those representations. But the challenges don’t end there. A buyer with concerns about the ability of the seller to satisfy its indemnification obligations naturally will want the indemnification provision to be backstopped by a substantial escrow. A seller, however, likely will not want a substantial portion of his or her personal wealth tied up in an escrow account to pay for liabilities related to a business with which he or she is no longer associated.

In this challenging context, R&W insurance might help bridge differences and facilitate the successful closing of the transaction. For example, a potential buyer can use R&W insurance as a means to avoid relying solely on the seller for indemnification. A potential buyer might be able to make an offer more appealing by incorporating R&W insurance into its bid to reduce the portion of the purchase price that will be held in escrow. Similarly, for a seller that is eager to divest a business and minimize the scope of its continuing obligations relating to that business, a carefully tailored R&W insurance policy may provide a greater level of comfort that the seller will not be forced to pay out of pocket to satisfy potential indemnification obligations.

The following scenarios illustrate some of the ways in which transactional insurance might be used effectively to facilitate a transaction or to make a particular proposal more financially appealing.

Scenario One: Show Me the Money

After spending 25 years building a successful manufacturing business, Jacob Marley has decided to retire and tour the world on a yacht purchased with the proceeds from the sale of his company. He retains an investment banker to put the business up for auction and receives interest from a number of private equity firms, including HavishamCo. Rather than grossly over-bidding its competitors, Havisham distinguishes its offer by including an escrow requirement that is dramatically lower than would normally be expected (subject only to Havisham’s ability to secure R&W coverage). While putting its bid together, Havisham negotiated terms of an R&W insurance policy to insure over the seller’s representations and warranties. The bid prices from the various private equity firms were roughly equivalent, but Havisham’s escrow holdback was several million dollars lower than in any of the competing bids. Thanks to this creative use of R&W insurance, Marley accepts Havisham’s bid and sails off into the sunset.

Scenario Two: Good Intentions and a Token Will Get You on the Subway

CogswellCorp is experiencing financial difficulty because its “visionary” CEO has begun expanding the company beyond its core cog-manufacturing business. In order to finance its ambitious growth strategy, Cogswell decides to sell its cog-manufacturing operations. SpacelyCo seizes the opportunity to purchase the operations of a longtime competitor, and the parties easily agree on price. In an effort to close the deal quickly, Spacely proposes a modest escrow of only $1 million. However, the cap on Cogswell’s indemnification obligations for breaches of its representations and warranties is significantly higher at $30 million. Although Spacely believes it is purchasing the fundamentally sound operations of one of its largest competitors at a bargain price, Spacely’s management team fears that Cogswell’s expansion efforts will fail, leaving the company unable to honor its indemnification obligations if called upon to do so. In order to address this concern, Spacely obtains an R&W policy that provides coverage above a retention amount equal to the escrow of $1 million, and the deal closes successfully.

Scenario Three: The Long Goodbye

Forty years ago, ApexCo was the world’s largest electronics manufacturer. The company also maintained one of the foremost R&D departments in the world and now holds patents for inventions that are widely used in data storage devices, computer chips and consumer electronics. Over time, Apex discovered that the licensing of its patents was far more lucrative than its manufacturing operations. After being acquired by a private equity firm, Apex shut down its manufacturing and marketing operations in order to focus on licensing its patents and vigorously protecting its intellectual property. Today, the company continues to own a number of shuttered manufacturing facilities and distribution centers in populous suburban locations. There is extensive environmental contamination at several of these sites, which makes them difficult to sell without providing broad, open-ended indemnifications to the buyers. In an effort to control the financial obligations associated with these facilities, Apex seeks the placement of stop-loss insurance that will apply to each of the properties. The underwriting process requires significant due diligence, testing and the preparation of estimates for the remediation cost at each property. Ultimately, Apex is able to secure a stop-loss policy that generally covers remediation costs above a threshold specified for each site. As a result, Apex is now able to market the properties knowing that its financial obligations will be fixed but that buyers will enjoy a level of assurance that additional remediation costs will be paid for under the stop-loss policy.

Scenario Four: Death and Taxes

Holding company Jarndyce & Sons consolidated a number of its subsidiaries into a new subsidiary, BleakCo. Based on the tax opinion of its law firm, Kenge & Carboy, Jarndyce believed that the roll-up had been accomplished through a series of tax-free transactions. Eventually, Jarndyce decided to sell Bleak and entered into negotiations with private equity firm PickwickPip. During due diligence, however, PickwickPip’s law firm, Dodson & Fogg, raised concerns about whether the roll-up transactions had indeed been tax free. Despite these concerns, PickwickPip felt strongly that Bleak would be a valuable addition to its portfolio. Because it disagreed with the tax position taken by PickwickPip’s counsel, Jarndyce was unwilling to place the full amount of the potential tax liability in escrow or to provide a full indemnity. Jarndyce, however, was willing to pay a portion of the premium for a tax insurance policy that would cover PickwickPip for any tax liability above an escrow amount agreed to by the parties in the purchase agreement.

A Strategic Solution

As these scenarios illustrate, transactional insurance can be used strategically by both buyers and sellers to overcome obstacles that might otherwise make it difficult to complete an acquisition or divesture. It is not, however, an off-the-shelf product. The underwriting often requires its own due diligence, and the terms under which coverage is provided frequently require intense negotiations. Accordingly, whether transactional insurance products might be useful in bridging obstacles to a transaction should be an early strategic consideration. Given the myriad issues and financial interests at stake, it is important that a potential purchaser of transactional insurance pay close attention to the risks for which coverage is sought, the extent to which the proposed coverage terms respond to those risks and the legal effects of the negotiated coverage terms.

© 2011 Much Shelist Denenberg Ament & Rubenstein, P.C.

Leasing Employees – Not a Risk Free Arrangement

Posted today at the National Law Review by  Melvin J. Muskovitz of Dykema Gossett PLLC – some of the key points to consider when considering entering into an employee leasing situation:  

While leasing employees from a staffing agency, either on a temporary or long term basis, is not a new phenomenon, the number of such workers is again increasing after reaching a low in July 2009, according to the Bureau of Labor Statistics. While there are a number of benefits to leasing employees, the arrangement is not risk free. This article discusses issues associated with the use of a contingent workforce.

Businesses may use temporary employment agencies to provide more flexibility with their workforce, maintaining a core workforce and utilizing temporary employees as the need exists. However, even though a staffing contract may state that the business is not the employer of thetemporary workers, it may be liable under various employment laws as a “joint employer” with the agency, despite the fact that the worker is paid by the agency and is not on the contracting business’ payroll.

Who is the legal employer?

Since the agency normally hires and pays the employee, provides workers’ compensation coverage, and if necessary, terminates the employee, it has an employer/employee relationship with the worker.However, during the job assignment, the entity to whom the worker is assigned may also be considered a joint employer depending upon the amount of control it exercises over the worker. A determination of joint employment is made by looking at the entire relationship

Factors to consider in determining if there is a joint employment relationship include:

  • the nature and degree of control over the worker;
  • the degree of supervision, direct or indirect, exercised over the work, including the scheduling of hours worked;
  • the furnishing of work space and/or equipment for the job;
  • the power each has to determine the pay rates or the methods of payment of the employee; and
  • the right each has to hire, fire or modify the worker’s employment conditions.

What is the liability for the joint employer?

If the agency and the client are held to be joint employers, both may be liable under federal or state employment laws.

Anti-Discrimination

If the entity to whom a worker is assigned treats that worker in a discriminatory manner, or subjects the employee to a hostile environment, it may be liable. Further, generally, the entity to which a worker is assigned is required to provide an accommodation if it has notice of the need for it and can do so without an undue hardship.

Family and Medical Leave Act (FMLA)

The FMLA generally covers private employers with 50 or more employees and all schools and public agencies. Employees jointly employed by two employers must be counted by both for FMLA purposes. If a temporary employee fills in for an absent one who is expected to return, both employees count toward the employer’s 50-employee minimum for FMLA coverage purposes. Part-time employees who work for a full workweek, including those hired through a temporary agency, count toward the 50 minimum for FMLA coverage.

When organizations are considered joint employers under the FMLA, only the primary employer is responsible for giving notices concerning FMLA leave, providing the leave, and maintaining health benefits.In a joint employment situation, the primary employer is the one that has the authority to hire or fire, assign or place the employee, and provide pay and benefits. The secondary employer is responsible for accepting an employee returning from leave if the secondary employer continues its relationship with the agency and the agency elects to return the employee to that job.

Fair Labor Standards Act (FLSA)

The FLSA makes both employers liable for minimum wage and overtime requirements.

National Labor Relations Act (NLRA)

Joint employers may both be liable under the NLRA if they share matters governing essential terms and conditions of employment such as hiring, supervision, disciplining and discharging. Therefore both employers may be found liable in an unfair labor practice. In addition,the National Labor Relations Board has taken the position that temporary employees from an agency may be included in a bargaining unit or voting unit if the temporary employees share a “community of interests” with the regular employees.

Occupational Safety and Health Act (OSHA)

Generally with joint employers under OSHA, the employer at whose business location the temporary employee is assigned will be the liable employer for work-related injuries. The staffing agency will normally be cited only if it knew or should have known of the unsafe conditions or if the citation is necessary to correct a violation.

Benefits Statutes

Depending on the terms of a business entity’s benefit plans, in addition to other factors, leased employees may be entitled to benefits provided to an entity’s regular employees.

Best Practices

1. Employers should seek indemnity agreements in the contracts they sign with temporary staffing agencies so that the agency retains liability for employment related claims and agrees to indemnify the client for any losses they may incur attributable to the actions of the staffing agency.

2. Contracts with staffing agencies should include a provision that makes the staffing agency responsible for payment of all federal, state and local employment taxes, including income taxes, FICA and unemployment taxes.

3. Employers should verify that the employees are covered under the staffing agency’s workers’ compensation policy.

4. Employers should accommodate the needs of a worker with a disability, or be able to justify why it would be an undue hardship to do so.

5. Employers should ensure that temporary or leased employees are not subjected to discriminatory treatment or harassment.

6. Employers should review all policies and benefit plans, to ensure that leased employees are not eligible to receive company benefits.

© 2011 Dykema Gossett PLLC.

 

Negotiating Your Law Firm’s Malpractice Insurance: How to Avoid Purchasing the “Never Pay Policy”

Recently posted at the National Law Review from Scott F. Bertschi of Arnall Golden Gregory LLP and John C. Tanner of  McGriff, Seibels, & Williams, Inc.- some very concrete things to look for when puchasing legal malpractice coverage: 

Far too many attorneys treat the purchase of malpractice insurance like that of an off-the-rack commodity.  The purchasing decision is guided largely by cost, advertising, or the relative ease of the application process.  Ironically, few attorneys actually read their own malpractice insurance policy until after they receive a claim. 

Instead, many law firms rely on assumptions in purchasing coverage and then set the policies aside, at least until a claim is made.  Then, the terms and conditions become all important, and that is precisely the time when you, as the insured, can do little to affect the coverage that may or may not be afforded under the policy.

The malpractice policies available in today’s commercial market vary greatly and insurance companies are more willing than ever to negotiate specific terms and conditions that can address the unique risks faced by you and your firm.  While the best way to take advantage of this opportunity is to use an experienced broker who will solely represent your law firm’s interests, this article provides a general roadmap for law firm administrators, general counsels, and managing partners to use in negotiating professional liability coverage.

1.         Don’t start off on the wrong foot.

The terms of coverage begin with the application process and, if you are not careful, coverage can end there as well.  The answers you provide on the application are used by the insurance company to determine the premium charged and the specific terms under which the insurance company is willing to insure you.  Of particular importance are questions regarding the areas of law in which your firm practices and whether any of the attorneys in the firm are aware of any circumstances that could result in a claim.

The temptation is to give these questions short shrift.  A full and complete answer usually requires a great deal of factual investigation, such as a review of past financial information to determine a break-down of revenues by type of work, and a polling of each attorney as to the knowledge of the existence of potential claims. 

Most off-the-rack malpractice insurance policies are written such that the insurer can rescind the policy in the event any of the application answers are incorrect.  Importantly, the insurance company doesn’t necessarily need to prove the firm intended to provide an incorrect answer.  Instead, an insurance policy can usually be rescinded for innocent mistakes in the application so long as the insurance company would not have offered the policy at the same premium or would have changed the terms if the correct answers were given. 

If the policy is rescinded, no claims made under that policy period would be covered, even if the claim is wholly unrelated to the mistake on the application.  Innocent insureds, not directly involved in the application process, are also at risk.  Additionally, rescission can make it challenging for the firm to obtain insurance in the future.

Accordingly, treat the application process like your coverage depends on it.  Specifically, the firm should commit the time and attention to the process necessary to get the answers correct.  If a question is unclear, ask for clarification.  Many insurers today will offer contract wording in the policy specifically protecting innocent insureds against rescission risk.  Once again, this is a process in which an experienced broker can greatly assist.

2.         What you know (or should know) can hurt you.

Legal malpractice policies, like most professional liability policies, are written on a “claims-made” basis.  Coverage under a “claims-made” policy depends primarily on when the claim was made, rather than when the error or loss occurred.  This creates a potential moral hazard: a prospective insured, knowing he committed an error, could purchase a claims-made policy before the claim is made and obtain coverage for a known loss.  Clauses called “prior knowledge provisions” are intended to protect insurers against this hazard. 

A typical prior knowledge provision states that claims based on errors occurring prior to the policy period are not covered if any insured had a reasonable basis to believe that a claim could be made.  Courts in many states apply an objective standard to determine whether an insured had such “prior” knowledge.   Thus, the question is not whether you specifically thought a claim would be made, but whether a ”reasonable insured,” knowing what you know, would believe that a claim is possible.  Moreover, depending on the policy wording, the knowledge of one attorney can eliminate coverage for all insureds, even those who do not have any “prior” knowledge.

When purchasing a legal malpractice policy, determine whether the prior knowledge provision contains a “continuity clause.”  This savings clause states the claim will be covered unless the insured had knowledge of the potential claim prior to the first policy issued by the insurer to your firm, rather than prior to the current policy period.  If possible, you should also seek policy language limiting the prior knowledge provision to a subjective standard requiring proof of fraud and otherwise protecting innocent insureds. 

In addition, most policies include provisions allowing insureds to provide a “notice of circumstance” to the insurer of potential claims – even if no claim has been made yet – specifically providing that any future claim arising out of that circumstance will be treated as a claim made during the current policy year.  Such a provision gives you greater flexibility when changing insurers, but pay close attention to the policy specificity requirements for reporting potential claims.     

3.         Prior Acts

Sometimes insurance companies also address the moral hazard inherent in “claims-made” policies by only covering claims based on errors occurring after a certain date, sometimes called a “retroactive” date or a “prior acts” date.  For previously uninsured firms or lawyers, most insurers will insist on a retroactive date equivalent to the policy inception date. 

Moreover, firms changing insurers often have the option of reducing the premium by agreeing to a retroactive date.  While this certainly limits the amount of coverage, the limitation can be offset by purchasing “tail” coverage from your current insurer.  “Tail” coverage, sometimes called an extended reporting period, extends the time in which a claim can be made and reported under an expiring policy for errors occurring prior to the policy expiration.  

Determining when an alleged error occurred is not always an easy task, however, and alleged breaches of care can span multiple policy periods.  If your firm nevertheless intends to change insurers, a qualified broker can help you calculate the most effective mix of retroactive date and tail coverage to maximize savings and minimize exposure to gaps in coverage.

4.         If a claim is made in the forest, and the insurer isn’t there to hear it, does it make a sound?

As discussed above, almost all legal malpractice policies on the market today are “claims-made” policies and apply only to claims made during the policy period.  Some, however, add the requirement that the claim be reported to the insurer during the policy period as well.  Such policies are aptly called “claims-made-and-reported” policies. 

In contrast to standard notice conditions that require the insured to report a claim “as soon as practicable,” numerous courts have  held that the reporting requirement in a claims-made-and-reported policy defines the scope of coverage, rather than states a condition for coverage.  What this means in practical terms is that the insurance company can disclaim coverage based on a failure to timely report the claim regardless of whether the delay caused the insurance company any prejudice.  Some policies flatly require reporting prior to the end of the policy period, while others provide that the claim must be reported within a 30 or 60 day time period after the policy expired. 

Another important consideration is the interaction of the reporting requirement and renewals.  Some policies specifically permit the reporting of a claim during the policy or any renewal policy, while others are silent on the subject leading to the possibility of a disclaimer, even when the renewal is with the same insurer.   

It is imperative that you establish a claim reporting procedure to ensure that all “claims” as defined in the policy are promptly brought to the attention of the firm’s risk manager or managing partner and reported prior to the policy reporting deadline.  Some insurers will agree to soften the claim reporting wording by requiring notice as soon as practicable after the individual in the firm charged with managing insurance and claims first learns of the “claim,” but few will agree to a prejudice standard or an unlimited timeframe for reporting post policy period.     

5.         Professional Services

As the name implies, a lawyers’ professional liability insurance policy covers just that: a lawyer’s professional liability.  Accordingly, it should not be surprising that such policies do not cover all liability a lawyer may face, merely because she is a lawyer.  Instead, it is well established that such policies only cover those risks that are inherent in the practice of law.  But what exactly does that mean?

Lawyers engage in a variety of law-related tasks that are not necessarily limited to lawyers.  For example, lawyers frequently act as title agents, trustees, conservators, administrators, arbitrators, and mediators.  Some firms today now have document management divisions or affiliated e-discovery and information technology companies.  The practice of law has expanded and continues to evolve over time.

Most legal malpractice policies specifically define the term “professional services.”  Be sure to check your particular policy definition against the activities your firm’s lawyers undertake.  Be especially careful when any of the lawyers in your firm have dual professional licenses, such as a lawyer who is also a CPA.  It is best to address such issues up front to avoid a surprise when the insurer disclaims coverage for a claim, contending that the alleged wrongdoing did not arise out of the lawyer’s rendering of “professional services.”

6.         Modern Day “Damages”

The typical legal malpractice policy limits coverage to claims for “damages.”  While that word seems innocuous, it frequently carries an express definition that serves to substantively limit what is covered. 

For example, many policies define the term “damages” to specifically exclude fines, penalties, sanctions, non-monetary relief, amounts demanded as the return of a payment of legal fees, or even the disgorgement of “funds wrongfully obtained.”  Most of these limitations are based upon the proposition that a liability insurance policy is designed to protect an insured from liability to another person, as opposed to a loss of the insured’s profit. 

One area usually open for negotiation is coverage for punitive or exemplary damages.  Of course, public policy places an outer limit on what types of punitive damages a policy can insure, but many states permit insurance for at least some types of punitive damages, such as those imposed vicariously. Many insurers today will provide coverage for punitive damages where insurable and subject to an insurability determination under the most favorable venue for such coverage. 

An emerging area of interest to law firms is coverage for Rule 11 or other discovery sanctions, as well as other “damages” arising out of claims of abusive or frivolous litigation.  While most insurers have historically excluded coverage for all fines, penalties, or sanctions, a few innovative insurers today have shown a willingness to offer a coverage sublimit to defend lawyers against such allegations.  Law firms can be jointly liable for an individual lawyer’s sanction-able conduct, and settlement exposure to claims of abusive or frivolous litigation is real.   Unfortunately, few firms today have adequate insurance protection in this area, and when available, it comes with an additional premium. 

7.         Intentional Acts Exclusion

Similar to the limitations on the insurability of punitive damages, public policy may limit an insurance company’s ability to cover liability based on an insured’s malicious, fraudulent, or dishonest acts.  Accordingly, every policy will invariably exclude such liability.  The problem is that legal malpractice claims frequently include intentional tort claims (such as breach of fiduciary duty) in addition to professional negligence.  The scope of coverage afforded such intentional allegations can vary greatly from one policy to the next. 

First, some policies exclude all coverage for such acts, including a defense to claims alleging fraudulent conduct even if the insured protests his innocence.  Under such policies, a common malpractice claim alleging both negligence and breach of fiduciary duty raises coverage issues at the outset because of the intentional breach of duty claim.

Other policies provide a so-called “courtesy defense,” under which a defense is provided until such time as the alleged fraudulent conduct is established by an adjudication or an admission.  Under such policies, the insurer may still insist on some allocation or insured contribution to a settlement of allegations of negligence when coupled with alleged intentional wrongdoing.  If possible, try to negotiate wording in your policy providing coverage for defense and settlement of alleged wrongdoing unless there is a final adjudication of such intentional wrongdoing in the underlying malpractice case, or in an action or proceeding other than a declaratory judgment proceeding brought by or against the insurer to determine the scope of insurance coverage.

Policies may also differ on the applicability of the exclusion to so-called “innocent insureds.”  Most exclusions apply to any claims “arising out of” the excluded conduct.  Courts generally hold that the “arising out of” language extends the scope of such exclusions even to negligence claims predicated on the intentional conduct, such as negligent hiring and supervision claims.  In other words, if your partner steals a client’s money, you are not covered even if you had no part in the theft.  Fortunately, many policies contain “innocent insured provisions” aimed at ameliorating this result.  These provisions waive the intentional acts exclusion for those insureds who did not actively participate in, and were not aware of, the excluded conduct.

8.         Business Enterprise Exclusion

Most lawyers familiar with the basic tenets of conflicts law know it is risky to represent a corporation in which an insured owns an interest.  Similarly, most seasoned lawyers know that such a situation can be rife with practical difficulty when the business enterprise fails. 

Insurers are aware of these problems as well and typically exclude claims made by any business enterprise in which any insured owns an interest or with respect to any enterprise operated, managed, or controlled by any insured.  The stated purpose of such an exclusion is to prevent an insured from transferring his own business loss to his legal malpractice insurer.  But the exclusions are not typically limited to claims against the particular lawyer who has the ownership interest and, instead, include claims by that enterprise against any lawyer in the firm.  Many insurers, however, are willing to negotiate this exclusion and give back coverage for some or all of such risks assuming the issue is raised and negotiated up front.   You should carefully evaluate the firm’s and its lawyers’ business interests each year in the underwriting process. 

9.         Coverage for Ethics Complaints & Disciplinary Proceedings

In addition to coverage for a lawyer’s monetary liability to a client or others, some legal malpractice insurance policies also pay for a defense to an ethics complaint or bar grievance.  Such coverage provides an obvious benefit over those policies lacking grievance coverage. 

Disciplinary proceedings and grievance coverage can differ between insurers as to whether the insured is permitted to choose his counsel, what control the insurance company retains over the defense, and whether there is a limit on the fees for such a defense. 

Many policies limit the coverage to a sublimit of $25,000-$50,000.  There is typically no retention or deductible applicable to such coverage, but the policy may only reimburse the insured after the successful conclusion of the proceeding.

10.       A defense by any other name does not necessarily smell as sweet.

Finally, but certainly not least important, all firms should carefully evaluate the defense provided by the insurance policy in the event of a claim.  The vast majority of legal malpractice claims are resolved with no payment to the claimant.  While this is good news for lawyers, it emphasizes the significance of the defense of such claims.  In short, the cost of the defense is often greater than the ultimate payment of the claim.  When you consider the fact that insurance policies vary greatly regarding the defense obligation, it becomes clear that this issue is rife with pitfalls.  Specifically, policies vary in two main respects. 

First, determine whether the limits of liability are “eroded” or “exhausted” by defense costs.  Under some policies, sometimes called “burning limits policies,” each dollar spent in the defense of the claim reduces by a dollar the amount available to pay a judgment or settlement.  Of course, purchasing a “burning limits” policy allows your firm to save on premiums, but it carries with it a risk that the limits will ultimately be insufficient should a claim involve a lengthy defense. 

Second, understand whether you or the insurance company chooses defense counsel and controls the defense.  Many legal malpractice policies are so-called “duty to defend” policies, which means that it is the insurance company’s right and obligation to defend the claim.  Typically, the right to defend carries with it the right to select defense counsel, and insurers often have negotiated volume discount rates with certain defense firms.  The “duty to defend” obligation is extremely broad, frequently said to require a defense of the entire claim if any part of the claim is potentially within the scope of coverage.  

On the other hand, so-called “indemnity for loss” policies simply reimburse your expenses incurred in the defense.  In such situations, the insured is generally afforded the right to select counsel and control the defense, but the insurer may require advance consent or agreement by your selected defense firm to negotiated lower rates or to predetermined litigation management guidelines.  The insurer may also take the position that it is not responsible for defending uncovered claims or allegations.

Many policies also include a “hammer clause” giving the insurer substantial leverage in the context of a potential claim settlement.  Such clauses in essence permit the insurer to withdraw its defense and cap its policy limit at any settlement amount recommended by the insurer and otherwise acceptable to the claimant.

Conclusion

Ultimately, there is no one “best” policy for all firms or any specific category of firms.  Instead, a firm’s legal malpractice policy should be carefully tailored to the specific activities undertaken by the firm and the firm’s individual financial situation.  Of course, insurance deals with the uncertainties of the future, and it is impossible to know now precisely what coverage you will need next year.  But you can maximize your odds by addressing your firm’s needs upfront and spending the time and effort to negotiate the scope of the policy before it is issued. 

© 2011 Arnall Golden Gregory, LLP and McGriff, Seibels, & Williams, Inc. All rights reserved.