Failure to Defend Insured Stops Insurer from Pleading Exclusion Must Vandalism Be Directed at the Insured to Trigger Coverage? Is Delivery of Policy to the Wholesale Broker Delivery to the Insured?

This month we’re going to look at three cases that may change the way you view insurance coverage. Two of them involve the New York Court of Appeals, which seems to be coming down on the insured’s side more frequently than in the past. And at the end we’ll quickly look at an item that intrigued me because it involved the Cleveland Indians and insurance-broker E&O.

Failure to Defend Insured Stops Insurer from Pleading Exclusion

It is universally recognized that the insurer’s obligation to defend is broader that its duty to indemnify. The insured need only show that the claim is potentially covered by the policy to trigger defense coverage. As a result, insurance companies often defend under a reservation of rights. That gives them to right to argue that the claim is not covered by the policy, if the defense is unsuccessful. A case supporting the insurer’s right to deny liability when it defended under a reservation of rights is Williams v. New York Cent. Mut. Fire Ins. Co.1 New York Central disclaimed coverage but provided a defense. Following depositions in the coverage litigation that ensued, the insurer sought to amend its answer to add affirmative defenses not raised in the disclaimer. The Appellate Division, Fourth Department, held that the insurer was not estopped from asserting the additional grounds because the insurer had provided a defense and expressly reserved its right to assert further grounds for non-coverage when it disclaimed.

Even just defense coverage can be valuable to the insured and expensive for the insurer. Not only can the insured avoid some legal expense, but the insurer will often settle the claim to stop the continuing litigation costs. In some cases, however, the insurer feels that it is so clear that the policy does not provide coverage that it refuses to defend the insured. That may change.

In what insurance defense attorneys are calling a stunning departure from existing law, but attorneys who represent insureds say is a boost for policyholders and a natural outgrowth of prior decisions, the New York Court of Appeals (New York’s highest court) has ruled that when an insurer is found to have wrongfully failed to defend a law suit against its insured, it may not thereafter argue that policy exclusions limit its obligation to indemnify its policyholder.

The case, K2 Investment Group, LLC, et. al. v American Guarantee & Liability Insurance Company, 2 involved an errors and omissions claim against an attorney. The insurer denied liability saying that the claim involved business pursuits other than the attorney’s legal work and refused to defend the insured. The attorney then defaulted in the claim against him and settled with K2 by assigning his rights against American to K2 in exchange for a release from all claims.

K2 sued American for coverage based on its assignment from the attorney. The court ruled that American was wrong. It wrote “when a liability insurer has breached its duty to defend its insured, the insurer may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him.” The K2 case was decided June 12, 2013; just two months later, it was cited in another decision, Samantha Lawrence v. Continental Casualty Company.3 In that case the court held that the insurer was obligated to pay a $132,000 default judgment against a nail salon for a customer waxing injury even though the insurer had obtained a signed statement from the technician involved admitting that she was not properly licensed. Based on that statement and a policy provision excluding coverage for bodily injury arising out of services rendered in willful violation of any Federal, State, Municipal or other law or regulation, the insured denied coverage and did not defend the insured.

The insurer did not pay the judgment, and a coverage suit was filed. The Court ruled in favor of the insured, holding that the insurer’s disclaimer was invalid because the allegations of professional negligence in the waxing injury complaint did not fall wholly within the exclusion. Moreover, the Court held that because the disclaimer was invalid, the insurer could not use the exclusion to deny coverage.

Randy Maniloff, an attorney with White and Williams LLP and author of the insurance law newsletter Coverage Opinions, is quoted as saying that “Even if the insurer believes that its risk of being wrong is very low, it may now choose to defend because of the significant consequences of a duty being found to have been owed. Insurers will decide to pay defense costs as a small premium for insurance against losing the ability to disclaim coverage for what could be significantly higher amounts.”4

Is this the law in other states? John Ellison of Reed Smith writes that “the decision actually embraces an estoppel rule for breach of the duty to defend that other courts across the country, such as Illinois, have recognized for years.”5

UPDATE: After this article was written, the New York Court of Appeals granted a motion to reargue the case. In its brief requesting a rehearing, American Guarantee contended that the court had given insufficient consideration to a prior decision, Servidone Construction v. Security Ins., 64 NY2d 419 (1985). In that case it held that an insurer that wrongfully refused to defend could still contest coverage based on a policy exclusion. Rehearing is expected early next year.6 More next month.

Is Delivery of Policy to the Wholesale Broker Delivery to the Insured?

Excess/Surplus lines are frequently placed through an intermediary excess line broker. Usually there’s a retail producer acting on behalf of the insured who submits the application to the wholesale broker. New York’s new law dealing with late notice in reporting a claim generated an interesting court case on who represents whom in such a situation. It also sheds light on New York’s new law on late notice. In October 2008, B&A Demolition & Removal purchased a combined general and pollution liability policy from Markel Insurance Company. B&A’s broker, Halland Companies, placed the coverage through Gremesco, a wholesale broker, on B&A’s behalf.

In 2009, while B&A was working on a building in Roosevelt, N. Y., Parabit Realty, the owner of an adjacent building, claimed that B&A and others were responsible for damage to its building. B&A was served with a summons on April 13, 2009 in this matter. As happens with appalling frequency, there was a delay in sending the summons to Markel; Markel didn’t receive it until November 17, 2009. On December 2, 2009, Markel denied coverage to B&A due to the late notice.

B&A argued that it was entitled to coverage because Markel was not prejudiced by the later notice. Under the revision to NY Insurance Law that took effect on January 17, 2009, an insurer must show that it was prejudiced by the delay in order to deny coverage to the insured. Markel responded that the new law applied only to policies “issued or delivered on or after January 17, 2009 and that the policy had not been delivered to the insured until after that date.

On December 1, 2008, Markel transmitted a copy of the Policy to Gremesco via e-mail. Gremesco claims that it was forwarded to the retail broker, Halland, the same day. Halland denied receiving the email and stated that it did not receive the policy, despite numerous requests to Gremesco, until February 18, 2009.

The issue for the court was whether delivery of the policy to Gremesco on December 1, 2008 constituted delivery to the insured. If so, the new law would not apply. If delivery to the insured did not occur until the policy was received by Halland, the retail broker, on February 18, 2009, then the new law would apply. While Markel regularly did business with Gremesco, Gremesco did not have an agency agreement with Markel. The court ruled that the wholesale broker was the insured’s representative and that delivery to that broker was delivery to the insured. Therefore, the policy was delivered prior to January 17, 2009 and the new law did not apply. B&A lost its coverage.7

Learning Points: (1) The new law didn’t save B&A, but it may rescue future insureds. Nevertheless, the better course: remember the three-fold claims handling formula: Report, Report, and Report. Prompt reporting will avoid arguments over prejudice. (2) Use care in selecting wholesale brokers. If the wholesale broker is the insured’s representative, then material misstatements by the wholesaler equal misstatements by the insured and may give an insurer grounds to deny coverage.

Must Vandalism Be Directed at the Insured to Trigger Coverage?

The New York Court of Appeals (New York’s highest court) had a busy year with insurance cases in the year just ended. In addition to the duty to defend case discussed above, the court decided insurance questions ranging from the meaning of “residency” in a homeowner’s policy to a broker’s liability for errors and omissions when the insured failed to read the policy. (The Westchester-Fairfield CPCU chapter is running a seminar on these decisions and others in November in Stamford, CT.) One question that the court didn’t reach, even though the US 2nd Circuit Court of Appeals certified it to them, concerned whether vandalism coverage applies when excavation at an adjoining building damages the insured’s building. Although the US Circuit Court of Appeals didn’t decide the case, some of their comments concerning the extent of vandalism coverage are most interesting.

Georgitsi Realty, LLC owned a building in Brooklyn that sustained significant damage due to construction and excavation work at adjacent property owned by Armory Plaza, Inc. Georgitsi had obtained a temporary restraining order to stop the work and the Building Department had issued numerous stop work orders, but the excavators nonetheless continued work. The excavators ultimately admitted to many violations of the stop work orders and paid $36,500 in fines to the city. Georgitsi claimed that the damage was due to vandalism. It was insured under Broad Form coverage, which is named peril, not “all-risk” coverage. One of the named perils was vandalism. Although Special Form is more commonly written, it’s generally agreed that special form coverage is at least as inclusive as broad or basic forms. Therefore the same argument could be made by an insured with special form coverage, even though special form is not a named peril form.

While the cause of loss may not sound like vandalism to you, the court did not reject coverage on that basis. It said “malicious mischief has been defined as the willful injury or destruction of property from ill will toward its owner or from mere wantonness,” but New York courts take a more liberal position. In New York, malicious mischief covers the “intentional doing of a wrongful act without legal justification” with no requirement that there be malice or ill will involved.8

The Appellate Court cited numerous cases showing that malice and ill will were not required. What stopped the judges from deciding the case at that point was the question of whether the conduct must be directed at insured’s property. The US court said that it could find no New York decision on that and therefore certified the question to the New York Court of Appeals.

Notice how broad the court says vandalism and malicious mischief coverage is in New York. The insurance textbook definition of vandalism says: “…both intent (“willful”) and motive (“malicious”) must be established for a loss to be considered vandalism.”9 This may not be accurate in New York and many other states.

Indians on the Warpath—Insurance Broker Watch Out.

This case caught my eye because it involves baseball, which I like, insurance broker E&O, which is of professional interest, inflatable slides, which I don’t like, and an email from a broker that’s an embarrassment. The accident even took place at a stadium to which an insurance company purchased naming rights.

The Cleveland Indians contracted with National Pastime Sports, LLC to run a “Kids Fun Day” event at a game at Progressive Field. The contract required National Pastime to provide a CGL policy naming the Cleveland Indians as an additional insured. National Pastimes directed its insurance broker, CSI Insurance Group, to obtain the required coverage. CSI placed the insurance with New Hampshire Insurance Co.

During the “Fun Day” event, a spectator was fatally injured when a large inflatable slide collapsed on him. Unfortunately, the New Hampshire policy excluded claims arising out of “amusement devices.” The application the Indians completed included a question about “bounce houses or inflatables,” which was checked yes. National Pastimes asked the broker what happened. Here’s the broker’s email response:

“Oh, ok. Sorry, I guess I missed it. I’m so used to quoting up your events I think I hardly look at anything but the dates and the details of the event.”

The next email from the broker quoted in the decision contained five grammatical mistakes in three sentences. I don’t know if the grammar influenced the court (they did mark them “sic,” which stands for “this is how it was written”). In any event, the court found in favor of the Indians.10 A California attorney has opined that the ruling would be similar in most other states.11 However, the Yankees or the Mets might not fare as well. New York courts often hold that the penalty for failing to obtain the required insurance is just the cost of the insurance.

1 2013 N.Y. Slip Op. 05156 (App.Div. 4th Dep’t July 5, 2013).

2 213 N.Y. LEXIS 1461, June 11, 2013.

3 2013 WL 4458755 (E.D.N.Y. August 16, 2013)

4 Bibeka Shrestha “NY Strikes Fear Into Insurers Waffling On Defense Coverage” www.law360.com Portfolio Media. Inc. www.law360. com June 12, 2013

5 John N. Ellison and Whitney D. Clymer “New York Court of Appeals embraces a more policyholder – friendly stance on insurer’s duty to defend” Lexology June 17, 2013 http://www.lexology.com/library/detail.aspx?g=2fcb1b6c-249c-4fab-9ffb-3974979f288f

6 Joel Stashenko “State Court of Appeals Sets Unusual Reargument” New York Law Journal 9/4/13 http://www.newyorklawjournal.com/PubArticleNY.jsp?id=1202617921103&rss=rss_nylj_news&slreturn=20130806100450

7 B&A Demolition And Removal, Inc. V. Markel Insurance Company (11-cv-0572 US District Court, E.D. NY April 18, 2013)

8 Georgitsi Realty, LLC v. Penn-Star Insurance Company U.S. Court of Appeals, 2nd Circuit. 11-4444-cv (12-21-12)

9 Jerome Trupin and Arthur Flitner, Commercial Property Risk Management and Insurance, 8th Edition, American Institute for CPCU, Malvern, PA, 2008

10 Cleveland Indians Baseball Co. v. N.H. Ins. Co., et al. US Court Of Appeals 6th circuit No. 12-1589 (8-23-13)

11 Barry Zalma “Cleveland Indians Win In Michigan” Zalma on Insurance August 27, 2013 zalma.com/blog/cleveland-indians-win-in-michigan/