Law and Insurance

Insurers Agree to Stowers Settlement of Patent Lawsuit

Good Sportsman Marketing LLC v. Non Typical, Inc., No. 6:07-cv-177 (Patent Case) (E.D. Tex. May 25, 2010) See Decision (settlement amounts redacted at request of the parties)

For insurance practitioners, this decision is truly a rare bird: a patent case that was settled in response to a Stowers demand.  The decision itself has little to do with the insurance issues.  The parties disagreed over the scope of the settlement and asked the judge to don his Solomonic robes and, well, do justice.  More on that later. 

I have commented before on the reasons that patent infringement rarely triggers advertising-injury coverage under a standard CGL policy (see Court Finds Patent Infringement a Covered Advertising Injury).  Usually, the patent-infringement claim is not covered, but the insurer's duty to defend is triggered by some other violation, such as trade dress, copyright, or (as in this case) false advertising.  Frequently, therefore, the most significant claims are not covered, but the insurer must defend the entire action anyway, which is why it is next to impossible to force the insurer to put in all of its chips in response to a Stowers demand to settle a patent lawsuit.

Stowers is the name given under Texas law to the doctrine that an insurer that unreasonably fails to  accept a settlement demand within policy limits must pay the entire judgment, even in excess of the policy limits, but only (in most cases) to the extent the claims are covered.  Because patent infringement (usually the lion's share of any judgment) is almost never covered, the insurer typically yawns at the Stowers demand. 

In this case, the plaintiffs alleged that their competitor, Non Typical, Inc. and its owner, infringed two patents for high speed camera technology and violated Lanham Act proscriptions against false advertising.  In this case, the false-advertising claims apparently had teeth.  One of two applicable CGL insurers agreed to defend from the first.  The second insurer balked, and a coverage lawsuit ensured.

Upon learning that two successive policies might be skewered, the plaintiffs served a Stowers demand for the limits of both policies (plus a sweetener that the defendants had already agreed to pay for the patent-infringement claims).  For whatever reason, the second CGL insurer had a change of heart and agreed to tender its limits along with the first insurer.  I suppose it realized that its Stowers exposure and the cost of the continuing defense were financially problematic.  At any rate, counsel for the recalcitrant insurer wrote a short note accepting the Stowers demand.

Usually that is the end of the litigation.  One of the parties writes up a settlement agreement, and the money changes hands.  Here, however, an argument erupted over the scope of the release with respect to the patent claims.  Did the settlement pertain only to past commercial activity, requiring the alleged infringement to be discontinued, negotiated, or litigated in this or a follow-up case?  Or did the settlement allow the defendants to continue selling the accused products, but now free of threats from the plaintiffs' patent rights?  The plaintiffs' letter was like most Stowers demands, saying:

 Plaintiffs hereby offer to settle and fully release all of their claims against Non Typical and [Owner] unconditionally for [stated $$ amount] . . .  [This release includes] any and all claims that have or could have been asserted against them by Plaintiffs in connection with the subject matter of the Litigation, including the patent infringement claims.

Shortly before the Stowers demand, Defendants had retained new counsel to lead the defense, including the patent defense.  After the Stowers demand was accepted,  plaintiffs' counsel demanded substantial additional money for a "paid-up" license or a commitment that the accused commercial activity stop or be further litigated, contending that the settlement didn't include future violations.  Defendants' counsel denied that defendants had agreed to anything like that, implicitly or otherwise.  So both sides filed motions for entry of judgment, asserting their respective understanding of the terms of the settlement.

The defendants argued that "any and all claims that have or could have been asserted" included plaintiffs' claim for a permanent injunction, which necessarily refers to future conduct.  Plaintiff argued both that an "injunction" is not a claim, but rather a type of relief, and that, under Texas law, the release language must explicitly "mention" the claim being released.  Future infringement was not mentioned in the release, said the plaintiffs.

Unfortunately for the plaintiffs, the case law and the equities weighed in favor of the defendants.  The cases plaintiffs relied on concerned releases that explicitly identified the temporal scope of the conduct being released.  Defendants found a Third Circuit case on all fours, Main Line Theaters Inc. v. Paramount Distrib. Corp., 298 F. 2d 801 (3rd Cir. 1962), holding that a release of injunctive claims necessarily released future infringement.  Also, the court noted that the plaintiffs had represented in pleadings that its motion was meant to "fully resolve this final matter so that the case may be dismissed."  Yet under plaintiffs' interpretation, only past conduct was resolved, leaving open the possibility of continued or new litigation.

It is worth noting that the case was brought in Texas' Eastern District, home of the so-called rocket docket for patent lawsuits.  The judge, Leonard Davis, is an experienced patent judge, and these settlements end either with the defendant obtaining a paid-up license or explicitly abandoning sale or use of the product.  In my experience, judges, faced with parties who can't agree over what they settled, will throw them both out to return to square one.  Judge Davis probably rightly caught the plaintiffs overreaching.

Returning to Stowers.  My theory is that any uncertainty over the the scope of the release resulted from the Stowers demand, which has become somewhat formulaic by virtue of a few Texas Supreme Court cases, such as Trinity Universal Ins. Co. v. Bleeker, 966 S.W.2d 489 (Tex. 1998) that arguably force claimants to use the "any and all claims" language stated above.  Also, the Stowers demand was directed toward the insurance companies to force acceptance of a policy-limits demand within a short time.  The insurers could care less about the uncovered patent claims, so the plaintiffs had no reason go into detail about future infringement.  Otherwise, the parties (or their lawyers) would probably have been clearer about their intentions for ongoing conduct.

Plaintiffs' counsel: Eric Buether of Buether Joe & Carpenter LLC

Defendants' counsel: Peter Jansson and Molly McKinley, of Jansson Shupe & Munger Ltd.

David S. White, Thompson & Knight LLP

www.tklaw.com

A Contractual Indemnification May Apply in a Two-Party Dispute, Says Texas Court

BP Products N. Am. Inc. v. J.V. Industrial Cos., LTD, # H-07-2369 (S.D. Tex. April 21, 2010) see Decision

Forgive me for yet another indemnification decision, but this is a rare case: adjudication of a indemnity dispute in which the injured plaintiff is also the indemnified party.  Usually, a third party sues the indemnitee, who then seeks defense and indemnification from the indemnitor.  Some judges have held that contractual indemnity applies only to third-party disputes, but, as this case shows, Texas law allows contractual indemnification to remedy breach-of-contract claims, unless the indemnity clause says otherwise.

BP Products hired J.V. Industrial to reinstall metal couplings on heat exchangers at BP's refinery.  BP alleges that J.V. mixed up the couplings, a mistake that resulted in a fire that destroyed BP's property.  The parties' contract contained the following agreement:

J.V. shall reimburse BP for, defend, indemnify, and hold BP harmless from and against all liability, costs (including reimbursement of all attorneys' fees and other costs of defense), loss, damage, expense, claims ..., suits, fines, and penalties on account of any and all ... damage to or loss or destruction of of any property (including without limitation, the [Contract Work]  and the property of J.V. and BP] arising directly or indirectly out of or in connection the performance of this Contract, whether caused or contributed to in whole or in part by the concurrent, joint, active, or passive negligent act or commission of BP or J.V.], except that J.V. assumes no liability for the sole negligent acts of BP.

In the lawsuit that followed, J.V. denied any responsibility for the damage and challenged BP's reliance on the indemnity clause, arguing that the provision applied only to third-party actions brought against BP.

The court first determined that, without regard to who brings the claim, the indemnity met Texas's "Fair Notice" requirements as stated in Dresser Indus., Inc. v. Page Petroleum, Inc., 853 S.W.2d 505 (Tex. 1993) (holding that the indemnity must expressly include the indemnitee's fault and appear in conspicuous type).  The court noted the absence of conspicuous type but acknowledged the parties' stipulation that J.V. was actually aware of the provision, which excuses lack of conspicuousness.

On the key issue, the court found that a party to the contract could recover for its own damage if the indemnity provision was written to permit this recovery.  Earlier Texas cases illustrate the principle:

1. In Kellog Brown & Root Int'l, Inc. v. Altanmia Comm. Mfg Co., 2008 WL 5114962 (S.D. Tex. Dec. 3, 2008), Altanmia's agreement "to bear, without right of reimbursement, the full risk of loss or damage" to certain vehicles used in performance of the contract did not obligate Altanmia to indemnify Kellog, because the provision did not expressly provide for indemnification of claims asserted between the parties.
2. By contrast, in Radiant Systems, Inc. v. American Scheduling, Inc., 2006 WL 2583266 (N.D. Tex. Sept. 7, 2006), Radiant's agreement (as the successor of the purchaser of software in question) "to be liable for 'Losses' resulting from the breach or falsity of any covenant or agreement made by the Purchaser," was held to specifically contemplate a suit for breach of contract by one party against the other.

The court noted that J.V.'s indemnity explicitly applied to the property held by the contracting parties, which necessarily affords BP a remedy for damage to its property.

We have in this case, therefore, two important lessons and one enigma.

First, the indemnity will include recovery for damage to the indemnitee's property only if the provision explicitly includes that right.  From the Radiant case, it should be enough if the provision covers loss or damage resulting from breach of the contract itself.

Second, this case provides comfort for those drafting high powered merger and buy-sell agreements that list each party's "reps and warranties," and then provide that indemnification will be the sole remedy for any breach of those reps and warranties.  It's nice to find some authority that this kind of indemnity is enforceable.

The enigma:  Do all indemnity agreements need to meet the Dresser test, described above?  Before addressing enforceability in a two-party dispute, the BP court first asked if the indemnity met the Dresser test.  I wager that it would come as a shock to most corporate lawyers who draft merger and buy-sell agreements to learn that they must add that the indemnity applies even if the indemnitee is negligent.  The purpose of this kind of indemnity is meant to cover one party's breach of contract that damages another party to the contract.  Why put in express-negligence language?

In the Dresser case, and in all other Texas Supreme Court cases discussing the Dresser test, the court was concerned with third-party claims against the indemnitee arising from the parties' joint contract operations.  The Dresser test is meant to prevent the unfairness of one party shifting liability for its own negligence to the other (presumably innocent) party, unless the contract explicitly says that the indemnitor is responsible even if the indemnitee is at fault.  However, that concern is not present when the contracting parties simply want the breaching party to reimburse the other party.

This snake in the grass bears watching.

David S. White, Thompson & Knight L.L.P.

www.tklaw.com

Court Finds Patent Infringement A Covered Advertising Injury

Hyundai Motor America v. National Union Fire Ins. Co. of Pittsburgh, No. 08-56527 (9th Cir. April 5, 2010) see Decision

This decision is a reminder of the potentially enormous value to businesses ensnared in intellectual-property litigation of an often-overlooked provision in just about every commercial general liability (CGL) policy, covering advertising injury.  This case is particularly remarkable because the court found that a patent-infringement allegation triggered the insurer's duty to defend, which almost never happens.  But even in copyright, trademark, trade dress, and other disputes over intellectual property that more readily trigger advertising-injury coverage, defendant companies often fail to check their CGL policies to see if their insurer might owe them at least a defense.  These type of cases usually cost millions to defend because the company's life blood may be at stake.  So, if your company is sued, check your CGL policy for the following:

Advertising Injury.  We are used to thinking of CGL policies covering bodily injury and physical damage to property, but standard policies also cover an odd assortment of offenses such as false imprisonment, invasion of privacy, wrongful eviction, malicious prosecution (my favorite), and advertising-injury offenses.  The insuring agreement is simple:  "[This insurance applies to:] "advertising injury caused by an offense committed in the course of advertising your goods, products or services . . .   "Advertising injury" is defined in this case as any of the following offenses:

1. Oral or written publication of material that slanders or libels a person or organization or disparages a person's or organizations goods, products, or services;
2. Oral or written publication of material that violates a person's right of privacy;
3. Misappropriation of advertising ideas or style of doing business; or
4. Infringement of copyright, title, or slogan.

The last two on the list are particularly apt in copyright, trademark, and trade dress litigation.

Two caveats: (1) the alleged injury must occur in the course of advertising, and (more tricky) (2) many jurisdictions, including Texas, also require that cause of the injury must be the advertising activity itself, not something else, such as the sale of the product being advertised.  Patent infringement usually fails this test because the injury is typically the sale of the infringing product, not the advertising.  This brings us to the Hyundai case.

Hyundai's Patent Infringement.  Hyundai, like most major corporations, maintains a website which  allows users to "build your own" (BYO) vehicle by navigating a series of menus of different colors, engine types, transmission types, and other options.  A customer may use a similar BYO feature to select customized parts.  A company called Orion IP, LLC holds patents for a "method of generating customized product proposals for potential customers of an automobile product."  Orion sued, alleging that Hyundai's BYO features infringed Orion's patents.  Hyundai sought a defense under its CGL policy, arguing that Orion alleged "misappropriation of advertising ideas."  The insurer denied the claim.  A jury found against Hyundai and awarded $34 million to Orion.  Hyundai then sued its insurer, seeking reimbursement of its defense costs but not the amount of the jury verdict.  (Not sure why Hyundai did not also seek coverage for damages, but advertising injury is often the tail wagging the dog -- only a tiny part of the lawsuit alleges advertising injury, which is enough to snag a defense but no more).

The coverage case was decided under California law, but the result would probably be the same in Texas and other jurisdictions.  The court first defined "advertising" as "widespread promotional activities directed to the public at large," which did not, however, encompass "solicitation."  The insurer had argued that use of a website entailed one-on-one solicitation, not advertising.  The court disagreed.  "A website is plainly directed to the public at large; therefore, the BYO feature constitutes 'advertising.'"

Misappropriation of Adverting Ideas.  The insurer next attempted to distinguish between the advertisement and the patented product and argued that the alleged injury concerned the patented product being advertised rather than the content of the advertisement.   The court again rejected the insurer's position.  Noting that patent infringement can qualify as an advertising injury if the patent involves "any process or invention which could reasonably be considered an advertising idea."  Here, said the court, "Orion patented a method of displaying information to the public at large for the purpose of facilitating sales."  In other words, Hyundai was using an advertising technique that was itself patented.  Thus, the infringement suit alleged an advertising injury.

Patent infringement fails to trigger coverage in most cases because the plaintiff complains that the defendant infringed the patent by manufacturing, advertising, and selling the patented product.  Courts routinely hold that the mere allegation that the product was advertised does not trigger coverage, because the advertising activity is not what caused the injury.  Sale of the patented product is the infringing activity.  That is why patent infringement is rarely covered.

However, insureds usually have a fair chance of receiving a defense in lawsuits in which the advertising, not the sale, caused the injury.  For example, if I infringe your copyright by advertising my product or service, and the advertisement includes material you copyrighted, the lawsuit should trigger the duty to defend because copyright infringement is an enumerated offense and the injury cannot be separated from the advertisement.  Even easier to cover are allegations over usurping trade dress or style of doing business in the course of advertising.  

Keep on your litigation check list: Is advertising injury alleged?

David S. White

www.tklaw.com

Kansas Still Recognizes Robust Bad-Faith Law, a Thing of the Past in Texas

Roberts v. Printup, 595 F.3d 1181 (10th Cir. 2010), see Decision

This sweetheart-deal case, serving up the hapless insurance company Kansas-style, is a reminder of how the art of bad-faith litigation used to play out in the Lone Star state before Gandy and other decisions tamed the wild west in the early 90's.  I couldn't resist pausing a moment over this case, sweet to recall for those legal giants who used to terrify insurers (here's to you, Rusty), and no less sweet for insurers, knowing they can no longer be dished up cold in Texas.

This variation of the sweetheart deal goes like this:  personal auto policy covers mother and son with maximum liability limits of $25,000.   Son drives auto into a tree, severely injuring mother, a passenger.  Insurer is notified and logs the claim as, "one-car accident, insured at fault."  Mother later tells the adjuster that the brakes failed, and she didn't think her son was at fault.  Insurer pays the no-fault personal-injury-protection (PIP) limit of $4,500, which is nowhere close to paying for mother's medical and hospital bills.  Insurer suspends further investigation.

A little less than 2 years later, mother consulted an attorney because she had heard that the policy might pay more than $4,500.  She then sent a letter to insurer, explaining that she was up against the 2-year statute of limitations in 10 days, she had over $150,000 in medical bills, and she would agree not to sue her son if insurer would agree to pay the $25,000 limits within 10 days. 

Now, freeze the frame.  At this point, the insurance company had done nothing wrong.  It acted promptly on the PIP claim.  The only claimant in the case, the mother, had stated that she didn't think her son was a fault, and liability was a condition for payment of the $25,000, which the mother did not claim until her demand letter.  So what did the insurer do? 

Insurer marked her letter "received" 8 days before the deadline but mistakenly sent it to the PIP department in Missouri, which mailed it back to the Kansas City Claims Department, where it was received three weeks after initial delivery, more than 2 weeks after the 10-day deadline.  Basically, folks, that's it.  From that point on, the insurer tried every way possible to stuff the $25,000, plus any attorneys fees incurred, into mother's hands, short of sending it with a Candy-gram.

Mother sued her allegedly negligent son, whom insurer defended.  Nevertheless, mother and son signed a settlement agreement (this is the sweetheart deal) in which son confessed judgment for $732,200 economic loss (past and future lost income), $250,000 for non-economic loss (probably pain and suffering), and $51,691.60 in medical expenses.  The agreement also proclaimed, "the settlement provided herein is fair and reasonable, is not collusive, and is entered into in good faith and as a means of amicably resolving their dispute."  The court entered judgment accordingly, and insurer, again, tried to tender the $25,000 limit.

Son then assigned his bad-faith claim to mother in return for an agreement not to execute the judgment (this is the second part of the bad-faith set up, formerly called the Texas two-step).  Insurer argued valiantly that its sin was only venial.  It missed the deadline by only a few days because of an inadvertent slip in the mailing room.  The lower court took pity on the insurer and dismissed the case, but not so on appeal to the 8th Circuit.

After reviewing Kansas bad-faith law, the court found:

It is readily apparent that it was foreseeable to [insurer] that its negligence in failing to implement a system to handle reasonable time-sensitive settlement offers from an injured party could result in a lawsuit being filed against its insured.  Accordingly, its attempt to accept the expired offer in this case did not absolve it of liability for damages to its insured caused by its earlier negligent failure to settle.

The court also found that mom's 10-day deadline was not arbitrary, but was justified given the impending statute of limitations.  (Reading between the lines, the court found no basis in the record for doubting the mother's story that she didn't find out that she might have a claim for the liability limits until shortly before the 2 years were up).  One can only imagine the firestorm that followed in the insurer's mail room.

That type of claim went the way of the cattle drive when the Texas Supreme Court ruled in State Farm Fire and Cas. Co. v. Gandy, 925 S.W.2d 696 (Tex. 1996) that a prejudgment assignment of the insured's claim was against public policy.  Four years earlier, the same court killed the sweetheart deal in Elbaor v. Smith, 845 S.W.2d 240 (Tex. 1992), forbidding a defendant from agreeing to testify against another defendant in return for a % in the plaintiff's recovery.

Nowadays, for good or ill, a plaintiff can only rarely survive an appeal of a bad-faith verdict against an insurer. 

5th Circuit Decision Is a School for Drafting Indemnity and Insurance Clauses

Travelers Lloyds Ins. Co. v. Pacific Employers Ins. Co., No. 07-20157 (5th Cir. April 6, 2010), see Decision

Upon learning the other day that the indemnity (or "hold harmless") provision in a ground lease was unenforceable for failing to meet the Texas "express-negligence" straight-jacket, a landlord client of mine sighed, "whenever I see the words, 'indemnification' or 'insurance,' my eyes glaze over."  True the world over.

This case is a tutorial for landlords (and other additional-insureds/indemnitees) on the fundamental difference between the indemnification clause and the insurance-procurement clause lurking in just about every lease.  Also shows why the indemnity is unenforceable.  The case is also notice-worthy for its (potentially troublesome) decision requiring the additional-insured's liability insurer to contribute to defense and indemnity under the so-called "other-insurance" clause in the insurance policy.

Insurance and Indemnity Clauses.  The lease between commercial tenant Best Buy and Landlord, which is typical in the real estate world, includes two separate clauses:

Tenant's Insurance.  Tenant shall obtain and keep in force at Tenant's expenses [sic] . . . commercial general liability insurance [specified amounts omitted].  Said insurance shall name Tenant as named insured and Landlord as additional insured . . .  .

Tenant shall indemnify and hold Landlord harmless from and against any and all claims, actions, demands, liens, costs, damages, expenses, and liabilities whatsoever including, but not limited to, attorneys fees and court costs arising out of any claims of any person or persons on account of: (a) any occurrence in, on or about the Premises . . . (b) the negligence or willful misconduct of Tenant . . . in, on or about the Premises.

A Best Buy patron was injured after slipping from the curb just outside the store.  Suit was brought against both Tenant and Landlord, whose respective insurers were duly notified.  Tenant's insurer refused to defend or indemnify Landlord, arguing that the indemnity was unenforceable, thus relieving it of any duty to defend Landlord as an additional-insured.  Landlord's insurer seems to concede that the indemnity is unenforceable, so let's start there.

Faithful followers of this blog know well why the indemnity is unenforceable because I comment on this vexed issue ad nauseum.  Even though the Tenant promised to hold harmless for all claims anywhere and everywhere, Tenant failed to say the magic words, "even if Landlord is negligent."  Texas's "express-negligence" rule requires an express stipulation in the indemnity clause that the indemnity applies even if the indemnitee is negligent.  Texas law also requires that clause stand out in boldface, all-cap, or other conspicuous lettering.  So, Travelers knew there was no point is arguing that the indemnity was enforceable, because it ain't.  Lesson one:  everybody check your indemnities.

Lesson two: the insurance-procurement clause stands on its own and will trigger coverage even if the indemnity fails.  I'm surprised Pacific even took a run at this argument.  Courts are instructed to ignore the indemnity clause when construing the insurance clause.  The accident occurred "on or about" the leasehold, which is close enough. 

Other-Insurance Clause.  Tenant's insurer next argues that Travelers at least has to share the cost of defense and indemnity by virtue of the "other-insurance" clause in just about every liability policy on the market.  Here Tenant's policy provides:

If other valid and collectible insurance is available to the insured for a loss we cover under this policy, this insurance is excess over that other insurance, unless that insurance is written specifically to apply in excess of the Limits shown in the Declarations.

Landlord's policy provides:

If other valid and collectible insurance is available to the insured for a loss we cover under Coverage A or B of this Coverage Part, our obligations are limited as follows: (a) This insurance is primary except when (b) applies. . . .  (b) This insurance is excess over any of the other insurance . . .  that is valid and collectible insurance available to you if you [Landlord] are added as an additional insured under any other policy.

Not surprisingly, both insurers claimed excess status over the other.  The lower court favored Landlord's insurer, holding that Landlord's additional-insured status met the exception in Tenant's policy that the insurance be written specifically in excess of the Tenant's policy.  The Fifth Circuit, however, disagreed.

The appellate court reasoned that "specifically to apply in excess of the Limits shown in the Declarations" applies only when the Tenant procures excess insurance that explicitly schedules the Pacific policy as underlying the excess policy.  So Travelers has to contribute to the defense and the settlement on an "equal-shares" pro-rata basis.

I said earlier that this holding was "potentially troublesome."  The lease required Tenant to purchase insurance that named Landlord as an additional insured, with no other specifications or restrictions.  I advise clients aspiring to additional-insured status to draft the insurance clause to also require that the named insured's policy be "primary and non-contributory" with the additional-insured's insurance.  How would the Travelers Lloyds court rule if that language was included in this lease?   I am not sure. 

If the lease required primary and non-contributory status, but the Pacific policy did not mirror that requirement in the policy, the court, arguably, would not rewrite the policy.  The result might be the same.  This might give Landlord a breach-of-contract claim against Tenant for failing to procure a policy that complies with the insurance clause, but that would likely give cold comfort to Landlord.  So

Lesson three:  Landlords and all additional-insured wannabees, insist on receiving a copy of the named insured's additional-insured endorsement soon after execution of the lease.  Do not rely on a certificate of insurance, which is not binding on the insurer.  I know this can be a pain, especially if you run a big operation with hundreds of leases.  But I know of no other way to verify that the other's policy matches the contract you spent so much time and attention drafting.  The court will look at the policy; so should you.

Better to add a drop or two of wash to those glazed eyes than lose thousands (millions) in coverage.

David. S. White, Thompson & Knight LLP

www.tklaw.com

Construction Case Shows 8-Corner Rule Dilemma Under Texas Law

Mid-Continent Cas. Co. v. Academy Development, Inc., No. H-08-21 (S.D. Tex. March 24, 2010) see Decision

Another Texas-size dilemma with the duty to defend.  This case illustrates an emerging tension between Texas's draconian 8-corner rule and its long-held policy of construing allegations liberally in favor of coverage.  A liability policy that provides a duty to defend requires the insurer to defend a lawsuit if even one factual allegation potentially triggers coverage.  The court must consider only the policy terms and the allegations in the lawsuit (the 8-corner rule) and construe those allegations liberally in favor of coverage.  But how should the court rule if the allegations are silent about a fact necessary to determine coverage but do not exclude that possibility?

In this homeowner-sues-developer case, the pleadings do not specify when the alleged damage actually occurred, which might have been within the policy period.  Before 2008, this problem would arise rarely, if ever, because we all thought Texas followed the "manifestation" trigger for property damage, fixing the time of an occurrence at the point that the damage manifested itself.  Lawsuits usually alleged when the homeowner first learned of the damage (probably because that date is relevant to show that the claim was not time-barred).  However, in 2008, the Texas Supreme Court suprised us in Don's Bldg. Supply, v. OneBeacon Ins. Co., 267 S.W.3d 20 (Tex. 2008) by holding that damage occurs, well, when it actually occurs, not when it is discovered. 

The court reached its ruling based on the plain meaning of the policy language (covering "property damage caused by an occurrence" within the policy period) but acknowledged that many courts applied a manifestation approach for convenience.  It is often a lot easier to know when damage is first discovered than when it first begins in fact.  This is especially true with building construction.  The owner finds the rotted floor and files suit, usually with no way of pinpointing the actual time damage occurred except sometime after construction began.

Getting back to the dilemma.  The owner alleges when construction began and when the damage was discovered, but nothing else to fix the time of actual damage.  Let's assume about half of that stretch of time falls within the policy period, and half before or after.  Under the 8-corners rule, the court may not consider extrinsic evidence, such as an engineer's expert report fixing the time when water first began seeping in, when the wood first began to decay, when support beams first started to fail.  Should the court hold that the homeowner failed to carry its burden of proof because no allegations show that the alleged damage occurred witin the policy period?  Or should it construe liberally and allow the duty to stand if the allegations, though silent, do not affirmative exclude the possibility that the damage occured within the policy period?

Texas courts split.  Gehan homes, Ltd. v. Employers Mut. Cas. Co., 146 S.W.3d 833 (Tex. App.--Dallas 2004) held that, if the pleadings do not state facts sufficient to clearly bring the case within or without coverage, the insurer should defend, as long as it is clear that potentially, the damage could have occurred within the required time frame.  By contrast, insurance companies rely on the recent Texas Supreme Court case, D.R. Horton-Texas, Ltd. v. Markel Int'l Ins. Co., 300 S.W.3d 740 (Tex. 2009), holding that a homeowner's lawsuit naming only the general contractor did not trigger the duty to defend, even though in fact, a subcontractor, not mentioned in the pleading, performed the defective work, a fact that would have brought the case within coverage.

I have discussed before the abject cruelty of a rule that places the duty to defend, or not, exclusively in the hands of plaintiff's counsel, who may not know or care that the decision to state or omit a fact determines the duty to defend.  (See Another 8-Corner Heartbreaker).  Nor does it help that the 8-corner rule is blind and strikes against policyholders and insurers with equal abandon.  A false allegation of a coverage fact can just as easily trigger undeserved coverage.

I would, however, argue for tilting toward the Gehan Homes approach when the case concerns latent property damage, as here, and the only reason for withholding a defense is silence over when the damage actually occurred.  That fact is so seldom alleged, and coverage is many times so plain, that a rigid application of the 8-corners rule as applied here is unsupportable.  For example, suppose the time from start of construction to discovery of the damage is five years, during which the policyholder had five consecutive policies.  We know that the alleged damage had to have fallen within at least one of the policy periods, but under the reasoning applied in this case, all five insurers would be entitled to summary judgment, even though all five potentially have a duty to defend. 

That is what the rule of liberal construction is for.

David S. White, Thompson & Knight L.L.P. 

http://www.tklaw.com/

Court Curbs Expansive Reach of Absolute Pollution Exclusion

National Cas. Ins. Co. v. Orior Transport, Inc. No. H-09-1539 (S.D. Tex. Feb. 22, 2010), see Decision

The so-called "absolute pollution" exclusion has become a fixture in commercial liability insurance policies for the last two decades.  It is called "absolute" because it excludes damage or injury caused by all releases of pollutants, including the "sudden and accidental" variety that had been routinely covered before the 1990's.  A "pollutant" includes just about any solid, liquid, or gaseous substance more noxious than water, dirt, or pure oxygen.  And a "release" can be no more than an inch or two movement from point A to point B.  In a word, the insurance industry has successfully plied the absolute pollution exclusion to deny claims having nothing to do with environmental pollution, such as the painter who falls off a scaffold from dizziness (caused by paint fumes), and the laborer unloading bags of cement who sustained eye injuries from the dust. 

This case went in favor of the policyholder following some very close parsing by the trial judge.  A trucking company in the business of hauling away salt water refuse from oil wells hired a welding contractor to repair one of its trailers.  Unfortunately, the tank had not been completely emptied from its last job, and some "potentially explosive residue" remained in the trailer.  During the repair, the potential became actual, and an explosion killed the welder.  The decedent's family sued the trucking company who sought coverage under a commercial auto policy with an absolute pollution exclusion.  The insurer refused coverage arguing that the explosion resulted from a release of the gaseous residue.

Before looking at the court's resolution, we need to look at the language of the exclusion itself, which has a few wrinkles found only in some auto policies.  The policy excludes:

"Bodily injury" . . . arising out of the actual, alleged or threatened discharge, dispersal, seepage, migration, release or escape of "pollutants" that are, or that are are contained in any property that is: (1) being transported or towed by, handled, or handled for movement into, onto or from, the covered "auto"; . . . [or] (3) being stored, disposed of, treated or processed in or upon the covered "auto."

This exclusion is triggered only if the pollutant release occurs during one of the enumerated activities.

The judge probably could have decided the issue without considering any of the activities.  The petition simply alleges that the explosion of the residue occurred while the welding was being done -- no explicit allegation of any "discharge, dispersal, seepage, migration, release or escape."  The insurer argued that some kind of release must be inferred.  How else can the welder's spark outside the trailer ignite fumes unless the fumes had escaped from inside the trailer? 

Without conceding the insurer's argument, the judge proceeded to the enumerated activities and found that the residue was not being transported, handled, stored, disposed of, treated or processed.  The insurer again argued that that one had to infer that the residue was present in the trailer only because one of the activities had occurred.  The salt water had been transported for disposal, and the stuff that exploded was residue of those activities.  Therefore, the residue should be treated as the equivalent of the salt water.

The court was unpersuaded.  Orion's motion for summary judgment was granted. 

Although the court didn't elaborate, at work here is the principle that, when determining an insurer's duty to defend, reasonable inferences should be drawn in favor of the policyholder, not the other way.  The insurer's arguments were plausible.  But the right question is whether the court could reasonably determine that, at the moment of the explosion, the residue was not being transported, handled, stored, treated or processed. 

Court Holds that D&O Insurer Cannot Unilateraly Decide If Excluded Conduct "In Fact" Occurred

Pendergest-Holt v. Certain Underwriters at Lloyd's of London, No. 10-20069 (5th Cir. March 15, 2010) see Decision

In this case, the Fifth Circuit considers a Director & Officers (D&O) insurer's refusal to pay defense costs to insured criminal defendants because an exclusion bars such payment when "it is determined that [money-laundering] did in fact occur."  The key issue for the reviewing court is who gets to decide when the excluded conduct "in fact" occurred.  Lloyd's argued that it could decide when the exclusion kicked in and why.  The insureds said that only a jury in the underlying criminal case could trigger the exclusion with a guilty verdict.  The court held that both sides were wrong.  A court, not the insurance company, had to determine if the exclusion applied and at what point.  But that determination did not have to await a final verdict of guilt or innocence.  The issue could be decided by a separate court in a coverage lawsuit.  Said the court, "This works a sensible construction of an awkwardly drafted instrument, aided by the equity power of the court to grasp the realities at hand."

This is a significant decision because many D&O policies have some kind of "occurred-in-fact" exclusion. Every D&O policy I have seen contains exclusions for certain kinds of bad conduct.  Most exclude deliberately fraudulent or criminal acts as well as receipt of illicit, undeserved profits.  Because no plaintiffs-lawyer worth her salt would draft a securities complaint that doesn't paint the directors' and officers' conduct in the blackest of terms, the bad-conduct exclusions in D&O policies are almost always potentially in play.  So, if the mere allegation of excluded conduct was enough to trigger the exclusions, directors and officers would never get the benefit of any coverage. 

In order to get companies to buy their D&O insurance, insurers' like Lloyd's, draft the exclusions to permit advancement of defense costs while the lawsuit is pending until the bad conduct is established in some manner, at which point, the spigot is turned off and the bad characters have to fend for themselves.  Often, the policy will even require the insureds to reimbursement the insurer for costs previously advanced.  Roughly speaking, the exclusions have one of two cut-off points: (1) when the bad conduct is established by a "final adjudication" (which the court in this case said always means adjudication in the underlying D&O proceeding - p. 16); or (2) it is determined "in fact" that the conduct occurred.

Here the D&O policy had a number of conduct exclusions, all but the the money-laundering exclusion to be determined after a final adjudication.  Unfortunately for the defendants, the policy described money-laundering very broadly, and just about all of the conduct alleged by the government in this ponzi scheme fall within the definition.  And this exclusion was triggered by an "in fact" determination.  So the court held that the insurer had to advance defense costs until a court decided the cut-off point.  That could already have occurred when one of the defendants copped a plea and pointed a finger at the others.   Or it may be established by other evidence.  Or it might have to await a jury verdict.

Interestingly, the court noted that the lower court judge who decides the issue might find that the exclusion has already been triggered, but an innocent verdict  would effectively reverse that determination.  That possibility is what the court had in mind when it referred to the courts' equity power.

On a final note, the appellate court held that the court hearing the criminal trial should not be the court to determine the coverage issue.  By its holding here, the Fifth Circuit has relegated to a footnote the extraordinary holding by the lower court that Lloyd's payment obligation should be decided under Texas' strict 8-corners rule that an insurer's duty to defend is determined with reference only to the allegations in a lawsuit, not to actual facts established by extrinsic evidence.  I say extraordinary because under this policy, and just about every D&O policy in existence, Lloyd's has no "duty to defend."  Its obligation is to indemnify the insureds for their defense costs, or, at best, to advance costs.  This is not the same as the more robust duty to defend. 

The Fifth Circuit pointed out that if the 8-corners rule applied, then the mere allegation of money-laundering would immediately settle the issue in Lloyd's favor.  The appellate court deftly characterized the 8-corner issue as a "red herring" and remanded the coverage action to some other court that was not burdened with the responsibility of rendering a fair trial in a high profile case. 

What's in a Name? Insured Loses Coverage By Failing to Inform Insurer of Name Change

VRV Development, L.P. v. Mid-Continent Cas. Co., No. 09-cv-1382 (N.D. Tex. Feb. 3, 2010) see Decision

The insured in this case lost coverage because it changed its name in 2005 from VRV Development, Inc. to VRV Development, L.P. and failed to change the named-insured designation on its liability policy.  Risk managers, take heed! On the named-insured designation, expect no tolerance with the identification of the business.  A corporation is not a limited partnership. A miss is as good as a mile. 

VRV Development, Inc. and its president, Kenny Marchant, are in the land development business, and contracted to build retaining walls on property to be developed into residential subdivisions.  The work began in late 2004 and ended in January 2006.  The company purchased general liability insurance in 2004, and renewed the policy in 2005.  On January 1, 2005, the corporation converted to a limited partnership, with Mr. Marchant as the sole limited partner.

Alas, by January 2007, the walls had begun to crack and tumble.  Lawsuit followed.  VRV Development L.P. submitted timely notice, but Mid-Continent looked at the policies and denied coverage.  The policies didn't cover VRV Development L.P. or Marchant as a limited partner.  The coverage lawsuit followed.

The insured made a valiant effort.  It produced solid evidence that the two companies were, in fact, the same entity.  It supported its argument for coverage with a provision of the Texas Business Organizations Act that an entity converting from one business form to another continues "without interruption" in its new form and retains "all rights, title and interests to real estate and other property owned by the converting entity" without any impairment of rights.

Yet the judge was unmoved.  First, Texas is the strictest of 8-corners jurisdictions.  Show me no extrinsic evidence to determine Mid-Continent's duty to defend.  Second, an insurer gets to choose who it insures. 

"Allowing [VRV] to substitute  a new party to an insurance contract, without Mid-Continent's knowledge or approval, and without giving Mid-Continent the opportunity to evaluate the entity or person it is purportedly insuring, materially rewrites that insurance contract in a way that would seem to contravene existing authority."

The kicker in favor of Mid-Continent is a policy provision that "no person or organization is an insured with respect to the conduct of any current or past partnership, joint venture or limited liability company that is not shown as a Named Insured in the Declarations."

Tragic.  One argument that VRV might make today that it did not have when it filed its summary judgment brief is that the Texas Supreme Court arguably blessed the submission of extrinsic evidence that shows the possibility of a duty to indemnify.  See D.R. Horton-Texas, Ltd. v. Markel Int'l Ins. Co., No. 06-1018 (Tex. Dec. 11, 2009) (See Markel Decision).  See my discussion of Markel here.  Evidence that the conversion to a limited partnership resulted in no substantial change in the business might allow VRV to prevail at the end of the underlying action, requiring Mid-Continent to indemnify even if there was no duty to defend.

But the best advice is to avoid this problem in the first place.  Keep your broker and insurer informed of your business reorganizations.

Judge Finds Policy Ambiguous But Rules Against Coverage. How Can That Be?

Jefferson Block 24 Oil & Gas, LLC v. Aspen Ins. UK Ltd, No. 08-cv-4792-JCZ-SS (E.D. La. Jan. 29, 2010) see Jefferson Block Decision

Every time I see a politically contentious senate confirmation hearing over the appointment of a judge to the federal bench, I am reminded of how seldom political philosophy or partisanship has anything to do with resolving actual cases and controversies, and, how hard good judges work to reach the legally correct result.  Facing the judge in this case are a host of perplexities, including out-of-state law (the policy selected New York law), a set of federal laws and regulations requiring insurance coverage for certain offshore pollution risks, and common law rules of interpretation over ambiguities, extrinsic evidence, and the policyholder's reasonable expectations.   On a very close call, the judge ended up ruling in favor of the insurers, but only after a careful and astute review of the facts.

The policyholder, Jefferson Block ("JB"), specialized in acquiring and reworking abandoned offshore oil and gas leases.  A federal law known as the Oil Pollution Act ("OPA") requires "responsible parties" to purchase clean-up insurance for any lease or "facility" (which includes pipelines) with a worst-case spill risk of more than 1,000 barrels.  JB acquired a $10 million OPA policy covering two leases and "facilities" in the Gulf of Mexico.  One of the pipelines leading from a covered lease leaked costing $3 million for the cleanup.

The insurers refused to reimburse JB arguing that the pipeline itself was not within the lease and was not otherwise scheduled in the policy.  Here is where it gets complicated.

The schedule refers to certain forms prescribed by an agency of the Interior Department that JB fills out and submits to the agency and the insurer.  One part of one of the forms allows JB to choose either a "General" or "Schedule" Option.  The General Option would cover all areas and facilities for which the insured could be held liable for cleanup under the Act.  Alas, JB chose the Schedule Option and failed to list the leaky pipeline.  But that doesn't end the inquiry because nothing in the form or the Act requires listing out-of-lease pipelines.  Being a federal regulation under a federal law, the matter appears hopelessly garbled.  The court, therefore, decided that the policy application and schedule were ambiguous.

At this point JB probably celebrated because usually ambiguities are resolved in favor of the insured.  That, however, is not exactly how the principle works.  When the contract is susceptible to two or more reasonable interpretations, the court must try to determine the parties' intent.  If extrinsic evidence (evidence outside the contract itself) establishes the parties' intent, then the court may consider that evidence even if it favors a decision in favor of the insurer.

It seems that JB hired a consulting firm to assist in the regulatory side of the insurance coverage.  Communications between JB and the consuting firm indicated that JB understood that the off-lease portions of the pipelines needed to be listed separately on the schedule.  The correspondence also tended to show that JB understood that the OPA didn't require coverage for the off-lease pipelines and that JB's intent was to obtain only as much coverage as required.

But here's the kicker in the court's view.  An email from a consultant helping prepare the agency form advised that he had shortened the application to show only two lines for the express reason that each additional line (required to list each pipeline) would generate more premium.  From all of the evidence, therefore, the court concluded that JB intentionally applied for more restricted coverage that did not cover the pipeline in question.  Since JB was the drafter of the application form that was ambiguous, the judge, in effect, reversed the usual rule that ambiguous provisions favor coverage.

The decision is worth a read to appreciate the court's careful, unbiased evaluation.  I have not mentioned some of the rabbit trails the insurer tried to run, dodges that the court examined and rejected.  In the end, this case presents a close call.  Some of the extrinsic evidence tilts against the insurer.  But the court deserves a round of applause for its effort, which upholds the best traditions of the American judiciary.