by Christopher Graham and Joseph Kelly

Two recent decisions impose severe consequences upon insurers that breach a duty to defend. A New York case, K2 Investment Group, LLC, et al v. American Guarantee & Liability Ins. Co, 21 N.Y.3d 384 (2013), involved a legal malpractice insurance policy. A Missouri case, Columbia Casualty Company v. Hiar Holdings, LLC, No. SC93026 (Mo. Aug. 13, 2013), involved a CGL policy. But the decisions are important for all duty-to-defend insurers in those states, regardless of the policy-type.

Under the New York K2 decision, an insurer wrongfully disclaiming a duty to defend, must indemnify its insured for any resulting judgment even if policy exclusions otherwise negate coverage. Lenders had sued an entity and its owners to collect on a debt, but then also sued an attorney/owner for legal malpractice, alleging that, as lenders’ counsel, the attorney failed to record a mortgage securing the debt. The legal malpractice insurer refused to defend the attorney/owner, citing exclusions for a “Claim based upon or arising out of, in whole or in part . . . D. the Insured’s capacity or status as: 1. an officer, director, partner, trustee, shareholder, manager or employee of a business enterprise . . . E. the alleged acts or omissions by any Insured . . . for any business enterprise . . . in which any Insured has a Controlling Interest.” The insurer thereafter also refused to settle for $450,000, well under the $2 million policy limit. The trial court in the malpractice and collection case then entered a default judgment against the attorney on the malpractice claim, for over the $2 million policy limit.

Lenders, as the insured attorney’s assignee, sued the insurer for breach of contract and bad faith. The New York Court of Appeals affirmed a judgment holding the insurer liable for the entire default judgment. It explained that “by breaching its duty to defend [its insured, the insurer] lost its right to rely on these exclusions in litigation over its indemnity obligation.”

Under the Hiar Holdings decision from Missouri, an insurer that wrongfully refuses to defend its insured is liable for all damages flowing from the breach, even exceeding the policy limits. The CGL insurer refused to defend and then settle a class action against its insured alleging violations of the Telephone Consumer Protection Act involving junk faxes. The insured with court approval settled with the class for $5 million, well over the $2 million CGL policy limit. The class then sued the CGL insurer under a garnishment statute, with the insurer counterclaiming for a declaratory judgment. The Court affirmed a judgment against the insurer for the entire $5 million settlement, finding the insurer breached its duty to defend claims alleging both property damage and advertising injury under the policy.

The New York and Missouri decisions are somewhat similar to what Illinois courts have been doing for quite some time. In Illinois, an insurer that fails to defend under a reservation of rights or bring a declaratory action is estopped from raising coverage defenses to an indemnity obligation, where it has breached a duty to defend. Doe v. Illinois State Medical Inter-Insurance Exchange, 599 N.E.2d 983 (1st Dist. 1992).

The insurer in the New York decision is seeking further review. So stay tuned. But these decisions are a red-flag for any insurer that caution is in order when declining a defense obligation in New York, Missouri, and Illinois.

Tags: New York, Missouri, Illinois, legal malpractice insurance, professional liability insurance, duty to defend, estoppel

by Christopher Graham and Joseph Kelly

As we’ve discussed previously on this blog, employee non-competition agreements in Illinois can be difficult to enforce; the Illinois Supreme Court in fact recently held that an initial offer of employment for an at-will employee isn’t enough to make a non-compete enforceable.

Employers may want to consider “gardening leave” as an alternative. Common in the United Kingdom, the employee provides a resignation notice and the employer then pays the employee not to work — for the employer or any other employer — for an agreed period.

Illinois courts have not addressed “gardening leave”, but some lawyers believe courts will look more favorably to a “gardening leave” provision than an employee non-compete.

For more information on “gardening leave”, see this excellent article by Kenneth J. Vanko.

Tags: Illinois, employment law, non-competition, non-compete, garden leave, gardening leave

The Uniformed Services Employment and Reemployment Act (“USERRA”) establishes rights for active duty military personnel and obligations for their civilian employers. USERRA was intended to assure that active-duty military personnel: (1) aren’t at a disadvantage in their civilian jobs because of their service; (2) are reinstated promptly to their jobs upon their return from service; and (3) aren’t discriminated against because of past, present, or future military service. Employers can fill a position while an employee is on active duty, but must offer to restore the employee to the job and benefits he or she would have attained if you had not been absent due to military service or, in some cases, a comparable job.

Unlike some employment laws which apply only when a company’s employees exceed a threshold amount, USERRA applies to all employers, regardless of size. Penalties for non-compliance can be severe.

Employers are required to provide notice to employees of their rights under USERRA. For more information, see the notice poster provided by the Department of Labor.

by Christopher Graham and Joseph Kelly

May an insurer rescind a legal malpractice policy for misrepresentations by one attorney, leaving that attorney’s innocent partner with no coverage? Not when there’s a severability clause; and because of the “innocent insured doctrine,” even if there is no such clause. So says the Court in Illinois State Bar Association Mutual Ins. Co. v. Law Office of Tuzzolino and Terpinas, 2013 IL App (1st) 122660 (Nov. 22, 2013).

Tuzzolino, for his firm, answered “no” to the renewal form question: Has any member of the firm become aware of a past or present circumstance(s) which may give rise to a claim that has not been reported? But he knew he should have answered “yes” because his client had threatened to sue. Terpinas, Tuzzolino’s partner, had no knowledge of the threatened claim then. He learned of the claim upon receiving a lien letter from the client’s attorney and then reported it to ISBA Mutual promptly. Client thereafter sued Tuzzolino, Terpinas, and their firm. ISBA Mutual sued to rescind the policy. The appeals court reversed a summary judgment for ISBA Mutual against Terpinas.

The following severability clause saved Terpinas from Tuzzolino’s false application answer:

The APPLICATION, and any addendum or supplements and the Declarations, are the basis of the Policy. They are to be considered as incorporated in and constituting part of this Policy. The particulars and statements contained in the APPLICATION will be construed as a separate agreement with and binding on each INSURED. Nothing in this APPLICATION will be construed to increase the COMPANY’S Limit of Liability.

Each insured thus had its own policy; so ISBA Mutual could only “partially” rescind — with no rescission for the innocent insured’s, Terpinas’s separate policy.

And based on the common-law innocent insured doctrine, Terpinas had coverage even absent severability: When multiple insureds share a policy and one insured’s actions would void the policy, coverage for the innocent insured remains.

Economy Fire & Casualty Co. v. Warren, 71 Ill. App. 3d 625 (1979) controlled. It addressed a fire insurance policy under which, a husband and wife, settled a claim with their insurer for loss of their home to fire. But the settlement was based on a fraud by the wife, who unbeknownst to the husband, had burned down the house. The insurer tried to rescind the settlement agreement, but the court held that the husband — unaware of the wife’s fraud — could keep half the settlement monies.

The Court in ruling for Terpinas refused to follow Home Insurance Co. v. Dunn, 963 F. 2d 1023 (7th Cir. 1992), where the Seventh Circuit supposedly applying Illinois law allowed a legal malpractice insurer to rescind, even when some insureds weren’t aware of a misrepresentation in the application.

Lesson for insurers: With a severability clause like the above, you won’t be able to rescind as to innocent insureds; and you may not be able to do so even without it, though there’s considerable uncertainty about application of the common-law innocent insured doctrine.

Tags: Illinois, legal malpractice, professional liability, rescission, innocent insured, severability

by Christopher Graham and Joseph Kelly

Some employers use the internet to learn about job applicants. What employers may not know is that using Google, Facebook or the like for applicant-screening could open them up to discrimination claims. Asking a job applicant or employee for a Facebook password in fact is prohibited under the law of Illinois and many other states as detailed in this recent blog post from Seyfarth Shaw’s Employment Law Lookout. That post also includes suggested best practices for assuring legal compliance including adopting policies, educating employees about them and why they’re important and, for employers doing business in multiple states, adjusting policies for state specific requirements.

by Christopher Graham and Joseph Kelly

Zurich American Ins. Co. v. Diamond Title of Sarasota, Inc., Case No. 8:10-cv-383-T-30 AEP (M.D. Fla. Dec. 4, 2013) addresses a common question-type in professional liability insurance applications — namely, did the applicant or prospective insured “know of any circumstances, acts, errors or omissions that could result in a professional liability claim against the Applicant?” Similar questions are in some D&O policy applications.

Rotolo, Diamond Title’s owner and President, answered “No” to the question, although involved in a mortgage fraud. Later, she pled guilty to related crimes.

JLO sued Diamond Title during the policy period for negligence in releasing escrow funds, but not fraud. Zurich then sued Diamond Title to rescind its professional liability policy, joining JLO to bind it to any judgment.

Like the insurance code of many states, Florida’s Code provides that “a misrepresentation in an application for insurance may prevent recovery under the policy if the misrepresentation was material to either the acceptance of risk or the hazard assumed by the insurer.” Fla. Stat. § 627.409.

The Court concluded the undisputed material facts established as a matter of law that Rotolo made a misrepresentation material to acceptance of the risk and the hazard assumed; so Zurich was entitled to summary judgment.

The Court rejected defendants’ argument that there was no misrepresentation. Citing the policy’s professional services definition and dishonesty exclusion, defendants argued in essence that because criminal mortgage fraud couldn’t result in a covered professional liability claim, Rotolo while knowing of mortgage fraud had no knowledge of acts that could result in professional liability claims. But according to the Court: “Rotolo was not relieved of her duty in the application to report acts that could result in a professional liability claim simply because the Policy may not have covered those acts.”

The Court also rejected defendants’ argument that the application wording altered Florida law, by requiring proof that Rotolo’s misrepresentation was intentional. The following “supporting” application wording said no such thing:

THE DISCOVERY OF ANY FRAUD, INTENTIONAL CONCEALMENT, OR MISREPRESENTATION OF MATERIAL FACT WILL RENDER THIS POLICY, IF ISSUED, VOID AT INCEPTION.

The Court also rejected defendants’ argument that Zurich failed to prove materiality. Contrary to defendants’ argument, it was immaterial that Zurich did not conduct the policy’s underwriting and immaterial that the underwriter’s affidavit referenced no underwriting guidelines. As the Court explained:

The Court does not need an underwriter or guidelines to appreciate how not knowing Rotolo and her employee had been committing mortgage fraud in excess of five years left Zurich unable to adequately estimate the nature of risk in issuing the Policy. [Citation omitted]. As previously discussed, many of these acts could have resulted in claims against the Policy. An objective insurer may not have issued a policy at all. Certainly a policy would not have been issued under the same terms and pricing knowing that Diamond Title was engaged in an ongoing scheme to commit mortgage fraud.

Tags: Florida, E&O, rescission, material misrepresentation

by Christopher Graham and Joseph Kelly

Adopted by the Supreme Court in 1988, the “fraud on the market” doctrine allows plaintiffs in securities cases to bring a class action without alleging reliance on false statements regarding securities. Much has been written about the Supreme Court’s grant of certiorari in Halliburton v. Erica John Fund and the future of the “fraud on the market” doctrine in securities class actions. The Supreme Court in Halliburton is expected to decide whether “fraud on the market” should continue. As explained by Kevin LaCroix in the D&O Diary and by Douglas W. Greene in D&O Discourse the impact of the Supreme Court’s ruling — expected in mid-2014 — on D&O claims for securities class actions could be significant.

by Christopher Graham and Joseph Kelly

William B. Kessler Memorial Hospital, Case No. A-2201-12T3 (Sup. Ct. N.J. Nov. 15, 2013)

Does a management liability policy require an insurer to defend an IRS claim for alleged failure to pay employment taxes, where “taxes,” “fines,” and “penalties” are exceptions from the definition of “Loss”? Not this one, according to this court.

The IRS claimed the insured hospital failed to pay what was owed for employment taxes for withholding and otherwise under the hospital’s quarterly Form 941. It demanded payment from the hospital and its trustees personally.

The policy included a duty to defend, providing: “The Insurer shall have the right and the duty to defend any Claim regardless of whether any of the allegations are groundless, false, or fraudulent.” Claim included “… any Insured Person Claim . . . .” “Insured Person Claim” included certain written demands, civil and criminal proceedings, and administrative and regulatory proceedings. “Loss” wasn’t incorporated into the “Insured Person Claim” definition, but it was used within the policy’s insuring agreement.

The insureds argued in essence that the “duty to defend any Claim” meant even a Claim for unpaid taxes and related penalties, for which the insurer had no indemnity obligation. In rejecting the insureds’ arguments, the court explained:

Plaintiffs’ main argument is that because North River’s definition of “Insured Person Claim” does not specifically refer to its definition of “Loss,” North River’s promise to “defend any Claim” must be honored notwithstanding that taxes and penalties are policy exclusions. In other words, even though North River might not be obliged to indemnify plaintiffs if they were ultimately made responsible for the section 941 taxes, plaintiffs were, nonetheless, entitled to have their defense costs paid for under the policy because the Internal Revenue Service was asserting an “Insured Person Claim.”

We are not persuaded by this overly-simplistic and literal interpretation of the policy. The notion advanced by plaintiffs would require North River to provide a defense against any and all claims lodged against its insureds, regardless of whether the claim embraced a covered risk. This novel interpretation is contrary to our settled jurisprudence with respect to liability policies, and not supported by principles of interpretation applied to insurance policies in general.

…

Plaintiffs’ potential exposure to the Internal Revenue Service’s effort to impose responsibility for section 941 liabilities is undoubtedly either a tax or a penalty. It is also clear that the policy excludes coverage for fines, penalties, or taxes. Nevertheless, plaintiffs argue that an Insured Person Claim and a Loss are two separate terms and provisions in the policy. They point to Section VI “General Conditions” as creating an independent duty to defend, regardless of whether the loss is contemplated by the policy. This fragmentary approach stands in contradistinction to our obligation to “interpret the policy as written and avoid writing a better policy for the insured.”

Tags: Duty to defend, loss, fines, penalties, taxes

by Christopher Graham and Joseph Kelly

Singletary v. Beazley Insurance Co., Case No. 2:13-cv-1142 (D. S.C. Nov. 5, 2013)

D&O insurance, as far as insurers are concerned, isn’t a means for insureds to transfer liability for contract obligations to their insurers. D&O policies frequently include exclusions for contractual liability. Wording varies. And the exclusions are frequently litigated, as you’ll see from earlier posts to this blog.

Beazley, the D&O insurer here, addressed contractual liability through an exception to the definition of Loss — for “damages representing amounts allegedly owed under an express written contract, including a guarantee or obligation to make payments.” The issue was whether the insured’s $500,000 repayment to the Social Security Administration fell within that exception to the Loss definition. This Federal District Court concluded that it did.

The insured, Family Assistance Management Services, was required to repay that amount as a result of a claim by the Social Security Administration. The Administration appointed Family Assistance as “representative payee” for social security and supplemental security income beneficiaries. “A representative payee is appointed by the [Administration] only after the commissioner conducts an investigation of the person or entity to determine that such appointment is in the interest of the individual due the [Social Security] benefits.”

Family Assistance’s former employee embezzled funds intended for those beneficiaries. The Administration found Family Assistance “did not adequately have controls over the receipt and disbursement of Social Security and Supplemental Security Income benefits” and, “as a result, the funds of beneficiaries were at at risk for improper safekeeping and use.”

So why did the $500,000 repayment qualify as for “damages representing amounts allegedly owed under an express written contract . . . ?” Family Assistance’s arrangement with the Social Security Administration was subject to a “Form SSA-11” which “includes a term requiring that the representative payee [(Family Assistance)] ‘[r]eimburse the amount of any loss suffered by any claimant due to misuse of Social Security or SSI funds by me/my organization.'” The Form SSA-11 was an express written contract. The $500,000 was damages representing amounts allegedly owed under that contract.

Tags: D&O, loss, contract exclusion

by Christopher Graham and Joseph Kelly

Quellos Group LLC v. Federal Ins. Co., et al, Case No. 68478-7-1 (Court of Appeals, Washington Nov. 12, 2013)

An insured with an $80 million loss takes a $5 million hair-cut off a $10 million limit in settling with a primary insurer and, as a result, is left with no excess coverage for $70 million in additional losses. Settling with the primary insurer for less than limits, thus, backfired.

The insured, Quellos Group — an investment firm — created a tax shelter for clients to offset capital gains with losses. But the shelter ran afoul of IRS’s rules, leading Quellos to pay a $35 million settlement and incur $45 million in defense fees.

The insured’s first excess policy from Federal with a $10 million limit provided that coverage “shall attach only after the insurers of the Underlying Insurance shall have paid in legal currency the full amount of the Underlying Limit.”

It’s second excess policy from Indian Harbor with a $20 million limit provided that it “will attach only after all of the Underlying Insurance has been exhausted by the actual payment of loss by the applicable insurers thereunder.”

The appeals court, in affirming summary judgment for the excess insurers, explained:

[T]he plain and unambiguous language of the excess insurance policies unambiguously states how the underlying insurance is exhausted. The policies require the underlying insurer to pay the full amount of its limits of liability before excess coverage is triggered. [The primary insurer] paid only approximately one-half of the $10 million policy limits and continued to dispute whether Quellos was entitled to coverage under the 2004-2005 policy for defense and other costs related to [the tax shelter.]

and

Because the exhaustion language in the Federal and Indian Harbor excess insurance policies is clear and unambiguous, we must enforce it as written, and affirm summary judgment dismissal of the lawsuit against Federal and Indian Harbor.

It didn’t matter that the insured paid the $5 million the primary insured didn’t pay, so that the insured’s and primary insurer’s combined payments totaled $10 million, the full amount of the primary policy. The excess policies’ wording required that the primary insurer actually pay its $10 million primary limit before any excess coverage would attach.

The Court also rejected the insured’s arguments that: (1) “only after” in the excess policies’ insuring agreements made exhaustion a condition, shifting the proof burden to the excess carriers to show prejudice; and (2) enforcement of the exhuastion language would violate public policy.

Tags: D&O, underlying, excess, exhaustion