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2008 Insurance Year in Review

By: Carl L. Blumenstein, James H. Vorhis
02/12/09

The crop of 2008 insurance cases demonstrates the familiar theme that policyholders must remain vigilant in protecting their coverage rights. Some of these cases also provide harbingers of significant upcoming developments. Here are the highlights:

• Where insurers commit unfair claims practices, they can be estopped from relying on express policy provisions to deny coverage.

• A New York federal court gave a helpful boost to California policyholders, holding that an insurer could not refuse to consent to settlements—even when only given last-minute notice. Will California courts follow that well-reasoned decision?

• Counteracting a recent California Supreme Court ruling, new statutes declare that non-negligent subcontractors need not indemnify nor insure others named in residential construction lawsuits.

• As attorneys and insurance professionals know all too well, policyholders with "claims made" policies cannot delay in reporting potential claims immediately to their insurers. The failure to do so jeopardizes valuable coverage rights.

Inequitable Insurer Claims Conduct May Estop Improper Denials of Coverage

City of Hollister v. Monterey Insurance Company (2008) 165 Cal.App.4th 455 illustrates in extraordinary detail the lengths to which some insurers will go to avoid paying legitimate claims.

After a city building was accidentally destroyed by fire, the insurer unreasonably delayed its investigation, failed to clearly communicate its coverage position and engaged in various other unfair claims practices. In order to obtain the functional replacement value under the policy, the City was required to enter into a construction contract within 180 days of the fire. The core issue in the case was whether the insurer's unreasonable claims handling, which deprived the owner of the funds needed for reconstruction, estopped the insurer from relying on that 180-day limitation.

While violations of the fair claims practices regulations (Cal. Code Reg., tit. 10, §2695.4 et seq.) do not support a private cause of action, the Court concluded that violation of those regulations could give rise to an estoppel against the insurer. Not relying solely on the regulatory predicate, the court also held that insurers have a common law obligation to assist policyholders in recovering bargained-for policy benefits. The decision should be a valuable precedent in other cases where insurers are obdurate in their claims handling or create other obstacles to legitimate policyholder claims.

Comment: To the extent insurers present unrealistic obstacles to policyholders, they may be equitably estopped from relying on express policy provisions to deny coverage.

Insurers' Failure to Consent to Weekend Settlement Equals Bad Faith, per Second Circuit

In Schwartz v. Liberty Mutual Insurance Company (2d. Cir. 2008) 539 F.3d 135, applying California law, affirmed a jury's verdict based on excess D&O insurers' failure to consent to a settlement.

The facts of the case are extraordinary. On the Sunday night before his trial testimony, the defendant CEO agreed to a $20 million settlement of a securities class action. He sent a 10 p.m. email asking four D&O insurers to consent to the settlement before trial was to resume at 9 a.m. the next morning. After all four insurers refused, the CEO wrote a personal check for $20 million and sued for coverage.

The excess insurers argued the policyholder could not settle without their consent and that, under the circumstances, the evidence did not support the verdict because the insurers had insufficient time to evaluate the settlement.  The Second Circuit rejected both arguments: Where the insurers were kept apprised of settlement negotiations over a course of months and also monitored trial developments, it was improper for them to refuse to consent to the settlement—even when given only a few hours to do so.

Comment: While this case had exceptional facts, the Second Circuit's decision has far broader significance: Insurers may not reflexively invoke the policy's consent clause to frustrate a settlement that is in the policyholder's best interests. Whether California courts choose to follow the nonbinding, albeit persuasive, reasoning of the Second Circuit remains to be seen.

Policyholders Must Promptly Report any Potential Claim Under a Claims Made Policy

In Westrec Marina Management, Inc. v. Arrowood Indemnity Company (2008) 163 Cal.App.4th 1387, an employee filed an administrative charge of discrimination with the Department of Fair Employment and Housing and requested an immediate right to sue letter, which the DFEH issued the next day. The employee's lawyer then wrote to the employer, advising that a right-to-sue letter had issued and proposing mediation. The employee filed suit against the company six months later.

Six weeks after suit was filed, the company tendered the claim to its D&O insurer. The insurer denied coverage, arguing that both the DFEH charge and the demand letter were "claims" under its D&O policies and that the post-lawsuit tender was untimely.

The Court of Appeal agreed. Enforcing the policy provisions for claims "first made and reported" during the policy period, the court held that both the demand letter and lawsuit involved the same claim and that the policyholder's untimely tender forfeited coverage.

Comment: Procrastination in the insurance context can cost policyholders dearly, especially with policies that contain standard "claims made" provisions. Although those provisions are common, brokers, attorneys and insurance professionals see far too many claims where coverage is lost solely because the policyholder failed to take prompt action. When policyholders receive some form of approach that can be viewed as a demand, they should immediately report it to their insurance company.

California Legislature Limits "Additional Insured" Coverage That Subcontractors Must Provide

The summer of 2008 brought a legal flip-flop to the ways in which parties may share and shift costs for residential construction defects—and for the "additional insured" coverage that protects against those risks. In Crawford v. Weather Shield Mfg., Inc. (2008) 44 Cal.4th 541, the California Supreme Court addressed the indemnification obligations of an innocent subcontractor that had obtained a jury finding that it was not negligent in performing its work. Because the subcontractor had contractually agreed to indemnify the contractor for defense costs arising out of the subcontractor's work, it was still required to pay the contractor's defense costs as soon as suit was filed.

Within just a few weeks, the Legislature passed AB2738, which become law on January 1, 2009, and is now codified as Civil Code §§ 2782, 2782.9, 2782.95, 2782.96. To protect non-negligent residential subcontractors, the law partially invalidates the Crawford decision, declaring that indemnity agreements—and insurance provisions—that require a non-negligent party to provide indemnity are void as against public policy. This protection cannot be waived. Subcontractors and their insurers are legally limited to contracts that require indemnity and defense arising from the subcontractors' own negligence.

Comment: The new statute codifies a policy of fairness - protecting non-negligent residential subcontractors from having to insure and/or to pay damages and expenses arising from the negligent work of others. But, significant questions remain. Pre-2009 indemnity agreements and insurance polices will be governed by pre-existing case law, including Crawford. Also, the new statute does not apply to non-residential construction contracts, so courts will be left to decide non-residential disputes under the old rules.

Briefly but significant: Ticconi v. Blue Shield of California Life & Health Ins. Co. (2008) 160 Cal. App. 4th 528 illustrates the principle that insurers may not rescind coverage based on misstatements in a policy application unless the application is physically attached to the policy. Here, the insurer could not use such post-claims underwriting to defeat certification of an unfair competition class action.

A Look Ahead to 2009 – a Challenge to Gray v. Zurich?

Because the broad duty to defend principle enunciated in Gray v. Zurich has been a touchstone of insurance precedent for over fifty years, the California Supreme Court surprised many by granting review of two cases in which insurers urge reconsideration of that precedent. In both Delgado v. Interinsurance Exch. of the Auto Club and Jafari v. EMC Insurance Companies two separate Courts of Appeal followed Gray in holding that insurers must defend their policyholders under policies covering "accidents" where the policyholders' conduct was alleged in the complaints to be, alternatively, intentional and self-defense. The insurers had argued that the alleged acts constituted intentional conduct that did not afford coverage under the policies' definitions of "accident." However, both Courts of Appeal held that the self-defense allegations were sufficient to give rise to the potential of coverage, thereby triggering the insurers' duty to defend.
One can only speculate as to whether the Court granted review in order to clarify that the established principles of Gray also apply to accident policies, or instead to impose some limitation on the reach of that precedent. The insurance industry has used these cases to make a frontal attack on the Gray v. Zurich rule. The lead case has been fully briefed since April 2008, so a decision is expected later in 2009.

Carl L. Blumenstein, a member of Nossaman's Insurance Coverage Practice Group, is a Litigation Partner with over 20 years of experience. Carl represents policyholders in insurance coverage litigation claims. He can be reached at cblumenstein@nossaman.com. James H. Vorhis is an Associate in Nossaman's Insurance Coverage and Financial Services Practice Groups and can be reached at jvorhis@nossaman.com.

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