Reservation of Rights Letters: Lack of Specificity Proves Fatal To CGL Insurer In South Carolina

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COLUMBIA, S.C. – Law360.com recently featured the South Carolina Supreme Court Ruling in Harleysville Group Insurance vs. Heritage Communities Inc. as one of the five most important but potentially overlooked insurance rulings in the first quarter of this year.  The Harleysville case points up  the peril insurers face for issuing general, non-specific reservations of rights letter.

In Harleysville, the South Carolina Supreme Court held that a reservation of rights letter which did not clearly state why a carrier believed a CGL policy may not provide coverage for a loss could bind the insurer to cover the loss.  The  Court affirmed a special referee’s decision that Harleysville was obligated to insure a prorated share of large verdicts entered against developers of two Myrtle Beach condominium complexes for a series of construction defect cases.

Harleysville agreed to defend the developer,  Heritage Communities Inc. and related companies in the underlying litigation under the CGL policies, but issued several reservation of rights letters during the defense which were used later to question the insurer’s coverage obligations.    A special referee ruled that the insurer had failed to properly reserve its right to dispute coverage for the actual damages verdicts against Heritage because the letters included only “generic denials of coverage” accompanied by verbatim copies of policy provisions.

The South Carolina high court agreed  that the reservations of rights letters were insufficient, as they did not adequately place the insureds on notice  of the insurer’s specific concerns and arguments against coverage.  Writing for the Court, Justice John W. Kittredge held:

“It is axiomatic that an insured must be provided sufficient information to understand the reasons the insurer believes the policy may not provide coverage…At the hearing before the Special Referee, Harleysville produced letters it sent to former Heritage principals and counsel between December 2003 and February 2004. These letters explained that Harleysville would provide a defense in the underlying suits and listed the name and contact information for the defense attorney Harleysville had selected to represent Heritage in each matter. These letters identify the particular insured entity and lawsuit at issue, summarize the allegations in the complaint, and identify the policy numbers and policy periods for policies that potentially provided coverage. Additionally, each of these letters (through a cut-and-paste approach) incorporated a nine- or ten-page excerpt of various policy terms, including the provisions relating to the insuring agreement,  Harleysville’s duty to defend, and numerous policy exclusions and definitions. Despite these policy references, the letters included no discussion of Harleysville’s position as to the various provisions or explanation of its reasons for relying thereon. With the exception of the claim for punitive damages, the letters failed to specify the particular grounds upon which Harleysville did, or might thereafter, dispute coverage… Here, except as to punitive damages, Harleysville’s reservation letters gave no express reservation or other indication that it disputed coverage for any specific portion or type of damages.”

(emphasis added).  Justice Kittredge went out to point out, for example, that Harleysville did not identify the basis on which it intended to contest that no “occurrence” took place, as defined in the policy.  On that basis, the Court affirmed the referee’s finding that Harleysville could not contest coverage under the CGL policies based on the reservation of rights letters it issued.

Editor’s Note:  The obvious takeaway here is that insurers should not skimp when it comes to the drafting of reservation of rights letters.  The better practice is to have inside or outside counsel prepare specific reservation letters as part of the coverage analysis or coverage opinion, if and when reservation letters are indicated. 

This ruling cautions against any conventional view that reservation of rights letters are merely “cookie cutter” documents that can be generated primarily by word processors.  Reservation of rights form letters may be used as a starting point, but never an ending point — the letters must ultimately contain specific gounds supporting any reserved claim, and wherever possible include citation to facts and information tending to suggest a reasonable dispute as to the terms of the policy on which reservation is being made.  CJH

Harleysville Group Ins. v. Heritage Communities, Inc., No. 2013-001291 (South Carolina, 2017)

Re-Purposing The Free Initial Consultation For The Benefit of Insurers and Corporate Clients

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Alternative fee arrangements are out of the bag by now.  They are being tried and used by insurers as part of ongoing efforts to bring cost-certainty to outside legal fees.  Badfaithadvisor.com has a complete survey of alternative fee options here.

But that is not the end of the leverage in favor of  insurers and corporate clients.  And to that end,  I am going to let you all in on a very big secret.  Not only that, I am going to invite — no — I’m going to dare, you to take advantage of it, and here it is:   I would rather my clients and prospects talk to me for free about matters of concern to them ,  than to let them  talk to any of my competitors.  Under any terms.

And so, the free initial consultation, long a staple of the plaintiff’s bar, has been co-opted and re-purposed for my insurance company and other corporate clients.

Insurance and corporate clients, and prospective clients who are interested in testing the waters, are given  free initial consultations of anywhere from 30 minutes to 2 hours (and sometimes more)  to review documents, and to discuss cases they are considering assigning to outside counsel.  But I offer the same thing to the same clients and the same prospects who are actually looking to AVOID sending a matter to outside counsel, too.  This provides value to them in the form of an informal first or second opinion which will give them early clarity on a matter, and peace of mind on potential action plans for handling those claims or matters.

The free initial document review / consultation is a win – win for clients and prospects.  If they do decide to retain me, on either en alternative or conventional fee basis, they have familiarized me with the matter they will be assigning and brought me up to speed at no cost to them, thereby reducing their overall legal expense on the matter.   If they decide to keep the matter in-house, they have received the value of an outside look for free, and I have hopefully created good will my clients will remember when the next matter comes up for consideration.

There are and will always be major coverage matters and bet-the-company litigation which insurers and corporate clients on which clients will seek outside representation.  Free initial consultations on both these matters and matters which clients never assign to outside counsel is another way to provide value to clients in business environments encouraging the limitation and reduction of outside legal expense.

C.J. Haddick

Water, Water Everywhere: Water Damage Exclusion Bars Coverage, Florida Judge Rules

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MIAMI, March 28 — A commercial property insurance policy’s water exclusion barred recovery for water related damage and  repair costs arising from a backed up pipe, a Florida judge has ruled.

In Ken Cameron and Michelle Cameron v. Scottsdale Insurance Co., No. 16-21704, S.D. Fla., 2017 U.S. Dist. LEXIS 45474, U.S. District Judge Marcia Cooke  granted Scottsdale’s motion for summary judgment in a coverage suit filed by the Camerons.  Scottsdale had previously denied coverage on a claim the Camerons made under a commercial property policy insuring their apartment complex after a pipe collapsed in the internal plumbing system and caused water and property damage.

Ken and Michelle Cameron originally filed suit in the 11th Judicial Circuit Court for Miami-Dade County, Fla., against Scottsdale Insurance Co., seeking a declaration that coverage was owed for water damage which occurred on one of their apartment properties. Scottsdale removed the action to federal court, and after losing an initial motion to dismiss, prevailed on a motion for summary judgment.

According to the suit, a  plumber found an “acute pipe failure” when the pipe collapsed.  Scottsdale denied coverage pursuant to an exclusion  for water – related losses.   Scottsdale argued that the policy in question did not cover damage from water originating from a drain.  The exclusion applied to  “water that backs up or overflows or is otherwise discharged from a sewer, drain, sump, sump pump or related equipment.”

The Camerons opposed the summary judgment motion claiming that the exclusion applied only to water backups or overflows deriving outside their property’s premises.
Judge Cooke held that the policy contained no definition of “drain” but that the term ordinarily refers to a “conduit for draining liquid, as a ditch or a pipe.”  She further held:

“Though the parties dispute whether the collapsed pipe was a ‘sewer’ and refer to the pipe by different names—a ‘sewer line’ for Respondent, a ‘sanitary line’ for Petitioners—it was, at the very least, a ‘drain.’  Parties do not seriously dispute this point or that there was a back up and overflow from the pipe.  More importantly, the [water exclusion] does not differentiate between drains found inside or outside the Petitioners’ property line or their plumbing system.  By its very terms, then, the [water exclusion] bars payment for the water damage and other repairs stemming from the Petitioners’ collapsed and backed up pipe… Because I find the [water exclusion] bars recovery for Petitioners in this case, it is unnecessary to analyze the other Policy provisions parties raise.  The lack of coverage for underground pipe damage is inconsequential, since it does not cover any purported water damage Petitioners allege.  The water damage exception does not impinge on the [water exclusion], as discussed above.  And I need not analyze the deterioration exclusion since the [water exclusion] undergirds my decision.”

Ken Cameron and Michelle Cameron v. Scottsdale Insurance Co., No. 16-21704, S.D. Fla., 2017 U.S. Dist. LEXIS 45474

Pennsylvania Federal Judge Finds Condo Policy Vacancy Exclusion Ambiguous; Rules Cincinnati Insurance Owes Water Loss

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SCRANTON, Pa., Feb. 10 — A Pennsylvania federal judge ruled Feb. 10 that a vacancy exclusion in a policy was ambiguous, and obligated Cincinnati insurance to reimburse its insured for water related losses.

In Village Heights Condominium Association v. The Cincinnati Insurance Co., No. 16-554, M.D. Pa., 2017,  U.S. Middle District John Jones granted the Condominium Association’s motion for summary judgment, holding that the sum total of the Condominium’s buildings were more than 31% occupied, and therefore not vacant within the meaning of the vacancy exclusion in the Cincinnati policy, and exclusion which the Court found ambiguous.

The Village Heights is  a community comprising 50 units consisting of stand-alone homes, and apartment units. Mr. and Mrs. Herb Graves, owners of  stand-alone Unit 205 were not living in their unit and had it up for sale.  In March 2015, while on vacation, a pipe burst occurred inside the Graves unit causing significant water damage to common areas owned by the Condominium Association.

Cincinnati declined coverage, claiming that the “Vacancy Provision,” precluded indemnity because the Graves’ unit was vacant for more than 60 days.  The Association filed suit against Cincinnati, and the case was removed to the U.S. District Court for the Middle District of Pennsylvania.

The parties in their cross-motions for summary judgment disputed whether “the policy was intended to insure the separate buildings, apart and distinct from each other, or whether the Policy meant to cover the nineteen buildings as one, making up a single ‘blanket building.’”  The policy defined a building as vacant “unless at least 31% of its square footage” is rented or used.

In finding for the Association, Judge Jones held that the exclusion was ambiguous on the issue of whether the policy provided blanket building coverage to the condominium association as a unified building or as separate buildings:

 “‘Simply put, the Policy’s Declarations do not define any terms, they merely identify the coverages available under the Policy.  Thus, the Declarations do not define a “Blanket Building,” but rather indicate that the Policy provides Blanket Building Coverage.  . . .’  Finally, the Vacancy Provision, which appears in Section Six (6) of the Policy, appears to contain its own separate definitions of the term ‘building,’ which differ according to whether the Covered Property is owned by an owner or general lessee, or is leased to a tenant and is with respect to that tenant’s interest in the property.  Where, as here, the Policy is issued to an owner, the Vacancy Provision defines ‘building’ as ‘entire building.’  In a subsequent paragraph, the Vacancy Provision then refers to “the building where ‘loss’ occurs” to further specify its terms, including a requirement that the building be vacant for sixty (60) days.”

Editor’s Note:  The Court’s ruling points to a potentially unintended exposure for property and casualty insurers.  Caution should be exercised by insurers regarding both  the wording of vacancy exclusions, and how units and buildings are defined when the policy in question insures Homeowners and Condominium Associations, as opposed to individual home or unit owners.

For a copy of  the opinion in Village Heights Condominium Association v. The Cincinnati Insurance Co., No. 16-554, M.D. Pa., 2017 (Jones, J.), email me at chaddick@dmclaw.com.

 

 

 

New York Rolls Out New Cybersecurity Requirements for Banks, Insurers

 

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Harrisburg, Feb. 22 –  According to the New York Department of Financial Services, new cybersecurity rules aimed at safeguarding consumer data go into effect on March 1, 2017.  The regulations  will require banks, insurers, and money services to strengthen their cybersecurity protocols by, in part, putting data security programs in place, and accepting greater responsibility for monitoring the vendors with whom they do business.  The rules also require reporting breaches within 72 hours.

The new rules impose obligations which could create liability from regulatory actions or consumer litigation. According to attorneys quoted in a recent article appearing on Law360.com,  the new guidelines will give enterprising  plaintiffs’ lawyers new claims against financial services firms, as well as firm directors and officers. Under the new DFS scheme, Company executives must certify compliance with the NY DFS regulations on an annual basis. Should those certifications prove incorrect, they could provide the basis for the DFS or consumers to make claims against banks, insurers and other financial services firms for breach of such certification.  Because of that, companies should devote considerable  attention and resources to two areas: 1.) implementation of cybersecurity programs and systems in compliance with DFS requirements; and 2.) making sure company executives have liability insurance coverage for cyber-related missteps, including coverage for both regulatory and consumer  claims.

With respect to adequately insuring cyber exposures, companies should undertake review of D&O policies to make sure any cyber-related liability is not excluded, and also that the insurance will cover the costs of defending against regulatory actions and any resulting penalties.  With respect to DFS requirements for the supervision of third-party vendors, the rules call for vendors to encrypt  nonpublic information and to set up robust protection systems.  Companies should require and review both vendor cybersecurity policies and related liability insurance products to make sure the vendors have technology errors and omissions coverage.  Companies may wish to secure additional insured protection in such policies as well.

A copy of the regulations may be found here:  nydfs-cybersecutiry-regs-03012017

 

 

Cybercrime Insurance Outlook 2017: Man vs. Machine

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HARRISBURG, Feb. 17 – As 2017 unfolds, it remains to be seen whether an emerging trend of stricter readings of cybercrime insurance policies to limit or exclude the reach of computer fraud  crimes protection coverage will continue.  One case decided late last year illustrates the trend, and the view that whether or not computer fraud coverage applies will be based in large part on the degree of human involvement in bringing about the criminal losses.

In Apache Corp. v. Great American Ins. Co, No. 15-20499, 2016 WL 6090901 (5th Cir. Oct. 18, 2016),  the Fifth Circuit Court of Appeals ruled that a policy covering losses arising out of computer fraud did not apply to a fraudulent financial transfer “that was the result of other events and not directly by the computer use.”

Of interest to the appeals court in Apache was that the crime started with a telephone  call from the thief, posing as a vendor to the insured, requesting a change of bank wiring instructions through which the insured paid the vendor.  Pursuant to Apache’s request  for the change of wiring instructions in writing, the thief provided the instructions via email, although the email address did not match the vendor’s email domain on file.  After a telephone call made by Apache following up the email , however, Apache instructed its bank to change the wiring instructions.

Apache discovered that the wiring change was ultimately fraudulent,  resulting in net losses of $2.4 million. Apache filed a claim with Great American under its crime protection insurance policy which included computer fraud coverage. The insuring agreement in the Great American policy provided for payment of losses “resulting directly from the use of any computer to fraudulently cause a transfer of [such money] from inside the premises or banking premises … to a place outside those premises.”

Great American denied the claim on the grounds that the losses did not result directly from the use of a computer, but rather human error.  Apache sued Great American for coverage in Texas state court,  and the case was removed to the U.S. District Court for the Southern District of Texas, after which both parties cross – moved for summary judgment. The federal district court granted the insured’s motion for summary judgment in favor of coverage,  and denied the insurer’s motion for summary judgment, but refused to impose statutory penalties on the insurer.

Following appeal by both parties to the U.S. Court of Appeals for the Fifth Circuit, the appeals court reversed judgment for Apache, relieving Great American of its indemnity obligations.  A three-judge panel held that that numerous intervening non-computer actions were taken between the digital actions of the posing vendor’s email and the computer bank transfer of funds.  Such non-computer acts, the court noted, included telephone calls, approval of the change in wiring instructions by Apache’s management, the receipt and processing of invoices by Apache, and Apache’s approval of invoices for payment.  The court finally found that Apache’s instructions to the bank to effectuate the wiring change were verbal as well.

The Court held:

“The email was part of the scheme; but, the email was merely incidental to the occurrence of the authorized transfer of money. To interpret the computer-fraud provision as reaching any fraudulent scheme in which an email communication was part of the process would. . . convert the computer-fraud provision to one for general fraud.. . . We take judicial notice that, when the policy was issued in 2012, electronic communications were, as they are now, ubiquitous, and even the line between “computer” and “telephone” was already blurred. In short, few—if any—fraudulent schemes would not involve some form of computer-facilitated communication. This is reflected in the evidence at hand. Arguably, Apache invited the computer-use at issue, through which it now seeks shelter under its policy, even though the computer-use was but one step in Apache’s multi-step, but flawed, process that ended in its making required and authorized, very large invoice-payments, but to a fraudulent bank account.”

For the Apache court, then, a critical area of focus in the analysis of coverage of cyber-crime insurance is the nexus between the crime, and the degree of computer, versus human, involvement. Apache, and decisions like it, impose rather strict limits on the scope of cyber-insurance coverage, setting a bright line between fraud which is primarily the result of flawed human systems, and fraud which is primarily digital, and computer-driven.

Cyber-crime and related technology insurance coverage is still very much an emerging insurance market.  Policy language, therefore, remains varied, and such variance imposes obligations on both insurers and insureds to be precise in their understanding of what kinds of protections  the policy terms, conditions, and endorsements provide.

Apache Corp. v. Great American Insurance Company, No. 15-20499, 2016 WL 6090901 (5th Cir. Oct. 18, 2016) 

In-House Legal Departments / Outside Counsel – New Year’s Resolutions

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As I look back over a year’s worth of posts, I can see that efficiency and cost certainty in the use of outside counsel by insurers is a common theme.  2017, I predict, will bring more of the same for insurance companies and their in house legal departments:  an institutional imperative to control costs and to gain cost certainty, in the matters they refer to outside law firms.  With that in mind, we take a quick look at some new year’s resolutions, and see whether there is any way to line up the resolutions of in house legal departments and outside law firms.

Resolution:  Know The Alternative Fee Options

The duty of outside firms to offer, and in house legal departments to utilize, alternative fee arrangements to continue efficiency in operations requires familiarity by both sides with the large variety of alternative fee tools available.  A complete review of some of the most common options appears on this resource page.

Alternative fee options are the language of efficiency in the engagement outside law firms, the coin of the realm for lean and effective operation in the years ahead.  It pays both insurers and outside law firms to be conversant in this language, and to communicate with each other in this language.

Resolution: Utilize Legal Project Management (LPM)

There has traditionally been an inverse relationship between insurers’ in house counsel affinity for LPM, and outside law firms’ competence and ability to provide it.  As insurers resolve again to control cost with effective LPM in 2017, competitive and responsive outside law firms must learn to use LPM effectively.  This requires repetitive use of LPM and case budgeting, and refining the process with each successive use.  It requires the reasonable cost projection of a legal matter, so the client can make informed decisions.

LPM projection and budgeting enable in house legal departments to make strategic decisions about which matters to fight, and which matters to resolve, and more importantly, when to do so.  LPM provides in house legal departments with important dashboard items, and they will increasingly expect outside law firms to provide these services as part of working for the insurer in 2017 and beyond.

Resolution:  Big Data Feedback

In a closely related resolution, in house legal departments at insurance companies will continue to expect more and useful data from outside law firms as to the value provided and the relationship of that value to the amount and type of the legal services billed.  Outside law firms must therefore continue to develop metrics tailored to each individual client to provide the client the data it needs and wants to make assessments as to whether matters are run efficiently, and outside law firms are providing value.

Outside firms which do not keep pace with the need to collect and feed back big data to clients on these issues will continue to lag in 2017 and beyond, and the pressure to keep up by providing requested data, and interpretation will be on the rise.

Resolution:  Cooperation and Collaboration, Not Conflict and Contention

The legal landscape is a challenging one now, and it is likely to continue to be so.  Outside law firms comfortable with the traditional hourly arrangement are oftentimes slow to modernize, and this failure creates a tension between a client and their outside lawyers on whether the fit is right, and whether the billable hour is in the best interests of the client.

Outside law firms must overcome such tension, and begin to view themselves as collaborators and business partners of the insurance in house legal departments they represent.  Alternative Fee Arrangements, LPM, and the aggregation and use of data to feedback to the clients are three primary vehicles for such positive change in 2017, and going forward .