Fireworks on the Fourth of July Lead to a Dispute Regarding a Landlord and Its Insurers’ Right of Action Against a Tenant

Post by Logan Wells

The Fourth of July is fast approaching, and so our thoughts turn to fun, freedom, and of course, fireworks. With that in mind, this post discusses a 2002 opinion of the United States Court of Appeals for the Fourth Circuit in which the court found that (1) S.C. Code Ann. § 38-75-60 did not bar an insured landlord’s action against its tenant for damages resulting from a July 4^th blaze; and (2) the presence of the landlord’s insurers in the action would not have reduced the amount of the insured landlord’s damages for which the tenant could be found liable.

In Balcor Equity Properties XVIII v. Caligo Limited, in early June 1994, Caligo began an industrial cleaning project in Greer, South Carolina. Caligo staffed the project in part with employees from outside the Greer area and housed these employees in apartments leased from Balcor, including Units 161 and 166. During the evening of July 4, some Caligo employees residing in Units 161 and 166 were discharging fireworks onto the ground from their outside balconies. The employees subsequently began shooting bottle rockets and Roman candles at each other. Shortly afterward, the wooden deck of Unit 164 (which was not leased by Caligo, but which was situated between Units 161 and 166) caught on fire, and the resulting blaze caused more than $1,000,000 in damage to the complex.

Balcor had purchased fire insurance coverage for the apartment complex from four different insurance carriers. After the fire, the carriers jointly paid Balcor $991,796.41, which represented Balcor’s claimed damages less its $100,000 deductible. Balcor then filed suit against Caligo in the United States District Court for the District of South Carolina, claiming Caligo was liable for the conduct of its employees in discharging the fireworks and seeking to recover damages in the full amount of the loss caused by the fire. Specifically, Balcor alleged, inter alia, that Caligo breached Paragraph 10 of the lease contract, which stated, “You agree ... to indemnify us from any damage or loss we may sustain because of any fire or the extinguishing of such fire originating in the premises which damages our property.” Caligo generally denied Balcor’s claims and also asserted that the action was barred by S.C. Code Ann. § 38-75-60, which provides as follows:  

Notwithstanding any other provision of law, no insurer has a cause of action against a tenant who causes damage to real or personal property leased by the landlord to the tenant when the insurer is liable to the landlord for the damages under an insurance contract between the landlord and the insurer, unless the damage is caused by the tenant intentionally or in reckless disregard of the rights of others.

In addition, Caligo moved to join Balcor’s insurers as involuntary plaintiffs; however, after the carriers stipulated that they would be bound by the judgment, the district court denied the joinder motion. The district court also struck Caligo’s § 38-75-60 defense, ruling the statute did not apply to Balcor’s suit, and inter alia, granted summary judgment to Balcor as to its breach of contract cause of action.

Caligo appealed, arguing the district court erred in granting summary judgment as to the breach of contract cause of action, in denying its motion to join Balcor’s insurers, and in striking its statutory defense. The court reversed the district court’s grant of summary judgment on the breach of contract claim. In addition, the court concluded the district court correctly ruled that § 38-75-60 did not bar the breach of contract claim because the statute bars insurers’, not landlords’, claims. For the same reason, the court also determined that the statute would not have barred Balcor’s claim even if Balcor’s insurers had been joined as involuntary plaintiffs. Thus, the court concluded that any error in denying Caligo’s motion to join the insurers was harmless.

On remand to the district court, following a jury trial, judgment was entered in Balcor’s favor for $1,050,000, which represented the entire amount of Balcor’s fire damage. Caligo moved to amend the judgment, arguing that it should be responsible only for the $100,000 in fire damage for which Balcor was not compensated by insurance benefits. Caligo further argued that Balcor’s insurers should have been joined as involuntary plaintiffs, and if they had been, § 38-75-60 would have barred recovery of the amounts paid by the insurers to Balcor. The district court denied the motion, noting that Caligo’s argument had been rejected earlier by the Fourth Circuit.

Caligo appealed, alleging inter alia that the district court erred in denying its motions to join Balcor’s insurers as involuntary plaintiffs. Specifically, Caligo contended that because Balcor’s insurers paid Balcor $991,796.41 as a result of the fire, the insurers owned a portion of Balcor’s claim. Caligo continued that had the insurers been joined as involuntary plaintiffs, they would have been prohibited under § 38-75-60 from asserting their claims, and therefore Balcor’s damages would have been reduced by $991,796.41.

The court rejected Caligo’s argument, finding the district court correctly ruled that the court had rejected Caligo’s precise argument in the first appeal. Further, the court found not joining Balcor’s insurers did not increase the amount of damages for which Caligo could be found liable:

In any event, Caligo’s argument that Balcor’s damages would have been reduced if its insurers had been joined as involuntary plaintiffs is simply incorrect. In partial subrogation cases, the insured’s right of action against the wrongdoer is "single and indivisible, even though the insurer is subrogated to the rights of the insured to the extent of the loss paid." Spearman v. J & S Farms, Inc., 755 F. Supp. 137, 141 (D.S.C. 1990); see Pringle v. Atl. Coast Line R.R., 47 S.E.2d 722, 724 (S.C. 1948). Additionally, South Carolina follows the "collateral source rule," under which compensation from insurance proceeds will not reduce the amount of damages for which the wrongdoer is liable. See Citizens & S. Nat’l Bank of S.C. v. Gregory, 463 S.E.2d 317, 318 (S.C. 1995); Otis Elevator, Inc. v. Hardin Constr. Co. Group, 450 S.E.2d 41, 45-46 (S.C. 1994) (applying rule in contractual indemnity setting). Accordingly, as we determined [previously], any error in not joining Balcor’s insurers as involuntary plaintiffs did not increase the amount of damages for which Caligo could be liable.

Accordingly, the court found Caligo was not prejudiced by the denial of its joinder motion, and therefore, affirmed the judgment of the district court.

Read More

Fourth Circuit Rules in Favor of Insurer That Refused to Defend or Indemnify Trucker

Finds “Business Use” Exception to the Policy Applies to Bar Coverage for Accident While Under Dispatch

On June 27, 2012, in an unpublished opinion, the United States Court of Appeals for the Fourth Circuit ruled in favor of an insurer that refused to defend or indemnify a trucker based on the commercial auto insurance policy’s “business use” exception, affirming a decision of the United States District Court for the District of Maryland.  

Post by Logan Wells

In Forkwar v. Empire Fire and Marine Insurance Company, Hameed Mahdi was a contractor for J&J Logistics, Inc. (“J&J”), working under an independent contractor agreement. Madhi leased his tractor to J&J, which paid Mahdi for its exclusive use of the tractor. J&J’s ICC numbers and the name “J&J Logistics” were on Mahdi’s tractor. Pursuant to the contract, Mahdi called J&J’s office each morning to see if J&J had a job for him to do. On November 25, 2004, Mahdi called J&J and was instructed to pick up a load in Jessup, Maryland at midnight on November 26. Mahdi left his home on November 26 and began to drive to Jessup. On the way, Mahdi decided to stop to grab something to eat, but before he could exit the highway he was involved in a collision with Augustine Forkwar.

Mahdi had been issued a commercial auto insurance policy by Empire Fire & Marine Insurance Company (“Empire”). After receiving notice of the accident, Empire conducted an investigation and determined that the “business use” exception to the policy applied, relieving Empire of any obligation to defend or indemnify Mahdi for the accident. The business use exception provided as follows:

This Insurance does not apply to any of the following . . .

14. BUSINESS USE

“Bodily injury” or “property damage” while a covered “auto” is used to carry people or property in any business or while a covered “auto” is used in the business of anyone to whom the “auto” is leased or rented.

Forkwar filed the underlying suit against Mahdi and J&J in October of 2006, alleging Mahdi negligently caused injury to Forkwar and that J&J was liable under the doctrine of respondeat superior. Empire declined to defend Mahdi on the basis of the business use exception. During the trial, J&J moved for a judgment as a matter of law as to the claims against it, which Forkwar did not oppose. Later, the jury found that Mahdi was negligent in the operation of his vehicle and awarded Forkwar $180,756.67.

After securing judgment against Mahdi in state court, Forkwar filed the action against Empire. The action was removed to federal court, and the parties filed cross-motions for summary judgment. The district court denied Forkwar’s motion for summary judgment, granted Empire’s motion for summary judgment, and denied Forkwar’s counter motion for summary judgment. Forkwar appealed arguing (1) Empire was collaterally estopped by the judgment in the underlying action from arguing that the business use exception applied; and (2) the business use exception did not bar coverage.

Collateral Estoppel

Forkwar argued Empire was collaterally estopped from claiming the business use exception applied because the issue of J&J’s respondeat superior liability was litigated and decided in the underlying action. The court disagreed, finding Forkwar could not meet her burden because the issue in the underlying action was not identical to the one presented in the action in question:

Under Maryland law, the doctrine of respondeat superior permits “an employer to be held vicariously liable for the tortious conduct of its employee when that employee was acting within the scope of the employment relationship.” Oaks v. Connors, 660 A.2d 423, 426 (Md. 1995)....[T]here are four elements to establish respondeat superior in Maryland: (1) the existence of an employer-employee relationship; (2) the tortious act must have occurred “within the scope of the employment relationship;” (3) the employer consented, explicitly or implicitly to the use of the automobile; and (4) the employer had the right to control the employee in the operation of the automobile or the use of the automobile was vitally important in furthering the master’s business.

In contrast, the business use exception applies whenever “a covered ‘auto’ is used to carry people or property in any business or while a covered ‘auto’ is used in the business of anyone to whom the ‘auto’ is leased or rented.” Plainly, the respondeat superior doctrine and the business use exception are not identical issues. While respondeat superior requires the existence of an employer-employee relationship, the business use exception has no such element. Thus, an individual like Forkwar who was acting “in the business of” J&J but who is an independent contractor rather than employee would be subject to the Policy’s exclusion without falling under the doctrine of respondeat superior.

In so finding, the court specifically addressed the Court of Special Appeals of Maryland’s language in Empire Fire & Marine Ins. Co. v. Liberty Mutual Ins. Co., 699 A.2d 482 (Md. Ct. Sp. App. 1997), wherein the Court of Special Appeals stated in construing Empire’s business use exception that it would “follow the course of other courts that have sought guidance from the analogous common law doctrine of respondeat superior.” Acknowledging there were some similarities in the requirements for the business use exception and the elements of respondeat superior, the court rejected the notion that the elements were identical:

It is true that the requirement in the business use exception that bodily injury occur while an auto “is used in the business of anyone” is quite similar to the second element for respondeat superior, that the accident occur “within the scope of the employment.” However, that is not to say that all of the elements are identical. Respondeat superior requires that there be an employer-employee relationship, and Maryland -- like other states -- recognizes a distinction between an employee and an independent contractor. See, e.g., Greer Lines Co. v. Roberts, 139 A.2d 235 (Md. 1958) (“Whether the relation of the parties is that of master and servant, or employer and independent contractor, depends upon the facts . . . .”). In contrast, no language in the business use exception suggests there must be an employer-employee relationship; it requires only that the accident occur while the auto is used in someone’s business. Thus at best Appellant has proven that one of the four elements of respondeat superior are met, but cannot establish the remaining three.

Accordingly, the court rejected Forkwar’s collateral estoppel claim.

Business Use Exception

Forkwar also argued the business use exception did not apply to the underlying action, arguing that Empire Fire & Marine Ins. Co. v. Liberty Mutual Ins. Co., 699 A.2d 482 (Md. Ct. Sp. App. 1997), was dispositive. The court disagreed, noting the timing of the accident in Liberty Mutual was different than the one involving Forkwar and Mahdi:

In ... Liberty Mutual ... the plaintiff, James Perry, was the owner and operator of a tractor that was contracted out to a shipping company, O.S.T.; the tractor’s I.C.C. license was in O.S.T.’s name. O.S.T. also had a similar method of assigning work: Perry contacted O.S.T. daily to obtain his next assignment. The timing of the accident, however, is different: Perry had completed his dispatch on January 16, dropped his tractor off at a service station that day, and returned four days later to pick it up. On his way home from the service station, he was involved in an accident. The Maryland court found that the business use exception did not apply, noting that Perry was driving to his home, not receiving any compensation from O.S.T., not operating under a bill of lading, not under dispatch, and not hauling a load at the time of the accident.

... While most of the facts parallel the instant case, in Liberty Mutual the accident occurred several days after the completion of Perry’s last dispatch, while he was driving home. Here, in contrast, Mahdi was under dispatch -- a fact expressly noted in Liberty Mutual.

(Internal citations omitted).

Lamenting the lack of additional case law on the applicability of the business use exception, the court sought guidance from outside the Fourth Circuit. Accordingly, the court followed the reasoning of the Seventh and Fifth Circuits, see Mahaffey v. Gen. Sec. Ins. Co., 543 F.3d 738 (5th Cir. 2008); Empire Fire & Marine Ins. Co. v. Brantley Trucking, Inc., 220 F.3d 679 (5th Cir. 2000); Hartford Ins. Co. v. Occidental Fire & Cas. Co., 908 F.2d 235 (7th Cir. 1990), and analyzed whether Mahdi’s conduct at the time of the accident “furthered the commercial interest” of J&J:

In applying the furthering-the-interests test to this case, we find that Mahdi’s conduct fell under the business use exception. The accident occurred while Mahdi was on his way to pick up a load for J&J; his driving to Jessup was a necessary step in completing his work. As the district court noted, Mahdi was not “pursuing leisurely engagement nor engaged in some frolic [or] detour.” Rather, he had received instructions from J&J to go to Jessup to pick up a load and was in the process of completing that task. Although Mahdi had decided just before the accident to stop for a meal before making his way to the warehouse, he was operating his vehicle at the time of the accident solely for the purpose of furthering J&J’s commercial interests.

The court therefore found that the business use exception applied to bar coverage, thereby affirming the decision of the district court.

Read More

Jessco, Inc. v. Builders Mutual Insurance Co: Part 1 - “Your Work,” Late Notice, and the Duty to Indemnify

Post by Logan Wells

A recent opinion of the United State Court of Appeals for the Fourth Circuit addressed a multitude of issues presented in litigation involving commercial general liability policies – the “your work” exclusion, late notice, and the duty to indemnify.

On March 29, 2012, in Jessco, Inc. v. Builders Mutual Insurance Co., the Fourth Circuit affirmed in part, reversed in part, and remanded by unpublished per curiam opinion the judgment of the United States District Court for the District of South Carolina, thereby finding that Builders Mutual Insurance Co. (“BMIC”) had a duty to defend Jessco, Inc. (“Jessco”) in the underlying construction-defect action, but BMIC was not obligated to indemnify Jessco for the re-grading allowance it paid to the underlying plaintiff homeowners.

In Jessco, Inc., the Mazycks hired Jessco to build a house in a North Charleston subdivision. After moving into the house in 2004, they provided Jessco with a punch list of items to be completed or repaired. These items were not resolved to the Mazycks’ liking, and in 2005, they filed the underlying suit against Jessco, alleging, among other things, that their lot flooded due to improper grading. In 2006, the action was stayed so the claims could be arbitrated. In the fall of 2007, experts for the Mazycks identified water damage to the house caused by the flooding of the property.

In October 2007, after the escalation in the Mazycks' demands, Jessco finally notified BMIC of the underlying claims. BMIC concluded the claims were not covered by the Policy and Jessco failed to promptly notify BMIC of the lawsuit. Accordingly, BMIC refused to defend or indemnify Jessco with regard to the underlying suit. Jessco thereafter filed a declaratory judgment action seeking a declaration that the claims in the underlying action were covered by the Policy. BMIC counterclaimed, seeking a declaration that it was not obligated to defend or indemnify Jessco.

The arbitration hearing on the Mazycks' claims was conducted in late 2008. The arbitrator issued his award in April 2009, ordering Jessco to pay almost $55,000 in damages. As to the flooding issue, the arbitrator concluded the flooding was proximately caused by "the overcapacitation of the wetlands, caused by the overall design and development of the surrounding neighborhood." Although the arbitrator found that Jessco's work was "not the legal proximate cause of the flooding of [the Mazycks'] property," the award included a $10,000 allowance for re-grading of the lot. BMIC appealed, challenging the district court’s determination that (1) BMIC had a duty to defend Jessco in the underlying action; and (2) BMIC had a duty to indemnify Jessco for the re-grading allowance.

Duty to Defend

In asserting it had no duty to defend, BMIC argued (1) coverage for the Mazycks’ claims was excluded by the Policy’s “your work” exclusion; and (2) Jessco failed to notify BMIC of the underlying lawsuit “as soon as practicable” as required by the Policy.

BMIC did not dispute on appeal that the allegations of the underlying complaint raised the possibility of “property damage” caused by an “occurrence,” but instead contended it had no duty to defend because coverage for the claims was excluded under the “your work” exclusion, which excluded coverage for any claims of “’[p]roperty damage’ to ‘your work’ arising out of it or any part of it.” “Your work” was defined as “[w]ork or operations performed by you or on your behalf,” a definition broad enough to encompass and preclude coverage for work done by the insured’s subcontractors. Although the Policy included an exception restoring coverage for damage to work performed by a subcontractor, it also contained an endorsement removing the subcontractor exception.

BMIC argued all the work on the property was done by subcontractors on Jessco’s behalf, and therefore, the “your work” exclusion barred coverage for all underlying claims. The court disagreed, noting “the exclusion does not withdraw coverage for any and all work done by the insured or its subcontractors; it withdraws coverage in cases where the insured causes property damage to work done by the insured or its subcontractors... ‘It does not exclude coverage for a third party’s work.’” (Emphasis in original) (quoting Limbach Co. v. Zurich Am. Ins. Co., 396 F.3d 358, 365 (4th Cir. 2005) (per curiam)). Thus, the court concluded, “the Policy’s elimination of the subcontractor’s exception means that Jessco’s subcontractors will not be viewed as third-parties for purposes of determining whose ‘work’ was damaged, but the elimination of the exception does not, as BMIC contends, preclude coverage if Jessco’s work in fact damages the work of a third party.”

The court determined the Mazycks’ claims against Jessco created a possibility that a third-party’s work or property was damaged by the faulty workmanship of Jessco or its subcontractors, noting the contract between Jessco and the Mazycks specifically contemplated that Mr. Mazyck would perform some of the work, and that Mr. Mazyck himself installed (or hired a subcontractor to install) the flooring and landscaping. Accordingly, the court found the “your work” exclusion did not bar coverage for the underlying claims.

With regard to “late notice,” BMIC argued even if the Policy otherwise provided coverage, Jessco lost its right to coverage by waiting more than two years to give notice of the underlying suit. Assuming for purposes of the opinion that notice was untimely, the court noted that under South Carolina law, “recovery under the Policy is barred only if BMIC proves that it was substantially prejudiced by the late notice.” See Vermont Mut. Ins. Co. v. Singleton, 446 S.E.2d 417, 421 (S.C. 1994) (“Where the rights of innocent parties are jeopardized by a failure of the insured to comply with the notice requirements of an insurance policy, the insurer must show substantial prejudice to the insurer’s rights.”); Squires v. National Grange Mut. Ins. Co., 145 S.E.2d 673, 677 (S.C. 1965) (“The burden of proof is upon the insurer to show not only that the insured has failed to perform the terms and conditions invoked upon him by the policy contract but in addition that it was substantially prejudiced thereby.”) Therefore, because BMIC failed to present any evidence of prejudice and “prejudice to the insurer may not be presumed,” the court rejected BMIC’s assertion that Jessco’s delay in notification precluded recovery under the Policy.

            BMIC also challenged the attorney fee award; however, it failed to substantively address the issue in its brief. Accordingly, the court found BMIC had abandoned the issue. See Wahi v. Charleston Area Med. Ctr., Inc., 562 F.3d 599, 607 (4th Cir. 2009) (“Federal Rule of Appellate Procedure 28(a)(9)(A) requires that the argument section of an appellant’s opening brief must contain the ‘appellant’s contentions and the reasons for them, with citations to the authorities and parts of the record on which the appellant relies.’ Because Wahi has failed to comply with the specific dictates of Rule 28(a)(9)(A), we conclude that he has waived his claims . . . .”).

Duty to Indemnify

BMIC also contended that the $10,000 re-grading allowance was not compensation for loss caused by a covered risk. Recognizing the Mazycks asserted contract and negligence based claims against Jessco in the underlying action, the Court determined that if the re-grading allowance was awarded by the arbitrator as compensation for negligence by Jessco in grading the property, Jessco’s negligence would constitute an “occurrence,” and the policy would provide coverage. Thus, the court first determined the legal basis for the re-grading allowance ordered by the arbitrator:

Although the arbitrator stated that Jessco and the Mazycks both “b[ore] some responsibility for the flooding,” the arbitrator ultimately determined that the flooding was caused by “the overcapacitation of the wetlands, caused by the overall design and development of the surrounding neighborhood.” The arbitrator concluded that the development and overcapacitation was “an unforeseen intervening cause,” and Jessco’s work was “not the legal proximate cause of the flooding of [the] property.”

The arbitrator’s determination that Jessco’s work was not the proximate cause of the flooding necessarily amounted to a rejection of any negligence-based claim asserted against Jessco. See, e.g., Hurd v. Williamsburg Cnty., 579 S.E.2d 136, 144 (S.C. Ct. App. 2003) (“It is apodictic that a plaintiff may only recover for injuries proximately caused by the defendant’s negligence.”). While there may have been some negligent conduct by Jessco, the proximate-cause determination means that Jessco could not have been held accountable to a third-party for that negligence. See, e.g., Howard v. Riddle, 221 S.E.2d 865, 866 (S.C. 1976) (“Plaintiff must show, as a matter of law, not only that defendant was negligent but also that his negligence was a contributing or proximate cause of the injury . . . .” (internal quotation marks omitted)).

Having established the arbitrator determined there was no actionable negligence on the part of Jessco, the court reasoned the re-grading allowance could only have been awarded as compensation for a breach of contract. Therefore, because the Policy unambiguously excluded coverage for breach of contract damages, the court found BMIC had no obligation to indemnify Jessco for the re-grading allowance paid to the Mazycks.

Having determined that BMIC owed a duty to defend Jessco in the underlying action, but did not owe a duty to indemnify Jessco for the re-grading allowance, the court vacated the district court’s judgment and remanded for further proceedings consistent with the opinion.

Part II of this blog post will discuss the decision of the district court on remand. We will post it on Tuesday.

Until then - have a wonderful Memorial Day. 

Logan

Read More

Insured's Participation in Investment Scheme Triggers Business Enterprise Exclusion

Post by Logan Wells

Fourth Circuit Finds Insured’s Participation in Investment Scheme Triggers Business Enterprise Exclusion Under Professional Liability Policy

On March 29, 2012, in an unpublished opinion, the United States Court of Appeals for the Fourth Circuit affirmed the judgment of the Eastern District of Virginia, holding that an insured’s activities as investor in companies for which the insured acted as legal counsel triggered the Business Enterprise Exclusion ("BEE") contained in the professional liability policy issued to the insured, thereby precluding coverage.  

In Minnesota Lawyers Mutual Insurance Company v. Antonelli, Terry, Stout & Kraus, LLP, the Antonelli firm and attorney Stout sought coverage for Ferguson v. Stout, a malpractice suit arising out of the alleged activities of the firm and attorney with respect to certain business entities they represented. According to the Ferguson complaint, inventor Andrew A. Andros formed Telefind Corporation in 1986 to develop and market wireless email technology (“WET”). In 1987, Andros and Telefind retained the Antonelli firm and Stout to perform patent prosecutions on its behalf; however, over time their role evolved from that of pure attorneys to equity investors to increasingly immersing themselves in counseling and managing Telefind’s strategy and operations.

Telefind received substantial financial backing from a group of outside investors (“Richards Investors”). The Richards Investors lent Telefind $6 million via a loan through Flatt Morris, S.A. The loan agreement stated Stout would serve as trustee for Flatt Morris and hold Telefind’s intellectual property in trust for Flatt Morris’s benefit. Over time, Stout and the Antonelli Firm acquired a majority equity share of Flatt Morris, including its Telefind assets.

Later, when it became necessary to protect the WET from Telefind’s creditors, Stout devised a legal strategy that he told the Richards Investors and Andros would legally protect Telefind’s interest in the WET, recommending placing the patents in a separate legal entity and stressing that their entire interest in the WET would be lost if they did not follow his advice. To implement the strategy, three employees of ESA Telecommunications (“ESA”), a company Telefind worked with previously, filed the WET patents in their names. Stout emphasized that for the strategy to be successful Andros and the Richards Investors could not have any documented direct ownership interest in the WET, assuring them they would continue to participate in any benefits associated with the WET. Andros and the Richards Investors disavowed their legal interest in the patents and the ESA employees assigned the patents to Stout. In 1992, Stout created NTP, Inc. to hold the WET patents.

Andros passed away in January 2001. Later that year, NTP filed a patent infringement action against Research in Motion Limited. RIM settled the suit in March 2006 for $612.5 million. The Ferguson complaint alleged the money was divided between Stout, his partners at the Antonelli firm, and others associated with NTP. When the Richards Investors and Andros’s surviving family contacted Stout regarding their interest in the proceeds of the RIM settlement, Stout denied the existence of any agreement conferring such an interest. Neither Andros’s estate nor the Richards Investors received any portion of the settlement. The Ferguson action ensued, asserting, on the bases of the above facts, claims of breach of fiduciary duty, breach of contract, unjust enrichment, and promissory estoppel. The Ferguson plaintiffs did not challenge NTP’s ownership of the WET patents, arguing only that the implicit understanding was that the Ferguson plaintiffs would receive a share of any WET profits.

The Antonelli firm and Stout notified their professional liability carrier, Minnesota Lawyers Mutual Insurance Company (“MLM”), of the Ferguson action. MLM filed a declaratory judgment action seeking a declaratory judgment that MLM was not obligated to defend the Ferguson action. Thereafter, the parties filed cross-motions for summary judgment. The district court granted MLM’s motion, finding that coverage for the Ferguson action was excluded by the policy’s BEE, which provided:

[This policy does not provide coverage for] any claim arising out of professional services rendered by any insured in connection with any business enterprise:

(a) owned in whole or in part;

(b) controlled directly or indirectly; or

(c) managed, by any insured, and where the claimed damages resulted from conflicts of interest with the interest of any client or former client or with the interest of any person claiming an interest in the same or related business enterprise.

The Antonelli firm and Stout appealed, arguing the Ferguson action was covered because (1) a number of terms within the BEE were ambiguous; and (2) even if the BEE applied to the Ferguson complaint on the whole, the Ferguson plaintiffs “might prove only the allegations falling within coverage without proving the allegations within the exclusion.”

Ambiguity

The Antonnelli firm and Stout first argued that a number of terms within the BEE were ambiguous and therefore should be construed in their favor, contending that favorable construction would demonstrate that the Ferguson complaint did not fall within the BEE.  Addressing each part of the BEE individually, the court rejected the argument:

Under the terms of the Policy, the BEE excludes coverage for claims (1) “arising out of professional services” (2) rendered “in connection with any business enterprise” (3) owned, controlled, or managed, by any insured, and (4) resulting “from conflicts of interest with the interest of any client or former client.”

There is no dispute that this case “aris[es] out of professional services” that Appellants provided to the Ferguson plaintiffs, thereby satisfying the first requirement of the BEE. Appellants counseled Andros and others to renounce their interest in the WET patents in order to avoid their creditors....

Further, and just as clearly, these “professional services” were rendered “in connection with [a] business enterprise,” meeting the second requirement of the exclusion. The phrase “in connection with” is a common insurance phrase that is given particularly broad scope. See, e.g., Goldman Paper Stock Co. v. Richmond, F. & P.R., 212 Va. 293, 296 (Va. 1971) (“in connection with” broader than “arising out of”); see also Coregis Ins. Co. v. Am. Health Found., Inc., 241 F.3d 123, 128-29 (2d Cir. 2001) (explaining “in connection with” encompasses more than causal connection); Metro. Prop. & Cas. Ins. v. Fitchburg Mut. Ins., 793 N.E.2d 1252, 1255 (Mass. App. 2003) (“In connection with” should “not be construed narrowly but [is] read expansively in insurance contracts.”) (collecting cases). Moreover, although the phrase “business enterprise” is not defined by the policy, there can be little dispute that it encompasses the various corporations involved here -- Telefind, Flatt Morris, and NTP.

The Ferguson complaint also clearly meets the third requirement of the exclusion since it alleges that Appellants owned, controlled, or managed at least Flatt Morris and NTP. Stout served as a trustee for Flatt Morris, and Appellants eventually acquired a majority equity interest. Similarly, Stout helped incorporate NTP. NTP had no employees and Stout, other attorneys at the Antonelli Firm, and their families were among NTP’s few shareholders.

Finally, the asserted damages surely resulted “from conflicts of interests.” The defendant attorneys in this case allegedly obtained complete ownership and control of their clients’ assets and exploited those assets for personal benefit. This conduct violates any number of Virginia professional ethics rules....

Accordingly, the court found the allegations of the Ferguson complaint fell unambiguously within the BEE.

Potentiality

The appellants also argued that even if the BEE applied to the Ferguson complaint on the whole, because the Ferguson plaintiffs “might prove only the allegations falling within coverage without proving the allegations within the exclusion, the district court should have found a duty to defend.” For example, the appellants argued, the Ferguson plaintiffs might prove that appellants provided professional services by advising their clients how to avoid their creditors, but fail to show that these services were rendered “in connection with any business enterprise” or resulted “from conflicts of interest.” Essentially, the appellants argued that the Ferguson action could amount to only a claim for legal malpractice.

The court of appeals rejected the appellants’ argument, pointing out that Virginia’s potentiality rule required the court to examine the complaint and determine whether any potential judgment under that complaint would fall within the policy. Such a process, the court emphasized, does not disregard the actual allegations that are made:

In the Ferguson complaint, each cause of action is premised on an agreement between plaintiffs and Appellants that they would share any WET proceeds. As both parties acknowledged at oral argument, because the plaintiffs consented to every initial step of Appellants’ strategy, if Appellants had shared the WET proceeds with the Ferguson plaintiffs, there would be no loss for the Ferguson plaintiffs to recover. Without any potential loss, there can be no duty to defend. See Va. Elec. & Power Co. v. Northbrook Prop. & Cas. Ins. Co., 475 S.E.2d 264, 265-66 (Va. 1996) (explaining insurer has no duty to defend where there is no possibility that insurer will be required to indemnify insured). Thus because the breach of the agreement is central to any potential recovery, Appellants cannot obtain a defense by having a court assume plaintiffs will fail to prove the heart of their allegations. Rather, we must evaluate the Ferguson complaint presuming that plaintiffs will prevail. In doing so, we conclude that MLM has no duty to defend because the BEE applies.

The court also rejected the appellants’ reliance on authority finding a duty to defend where alternative allegations fall within the policy:

Appellants’ reliance on authority finding a duty to defend where some alternative allegations fall within the policy is also unavailing. Cases considering alternatively worded complaints do not look to any conceivable cause of action. They require that the complaint actually asserts the claim. See, e.g., Fuisz v. Selective Ins. Co., 61 F.3d 238, 245 (4th Cir. 1995) (avoiding intentional act exclusion because “each of the four causes of action” alleged “reckless disregard” in addition to “actual malice”). Given that the Ferguson complaint does not assert legal malpractice as an alternative theory, we will not infer such potential liability.

Thus, the court found that the BEE exclusion applied to exclude coverage for the Ferguson action.

 

Read More

Fourth Circuit Rules that FLSA Claims Constitute “Wrongful Act” Under CGL Policy

Post by Logan Wells

In a decision published February 24, 2012, the United States Court of Appeals for the Fourth Circuit held that an insured’s violation of the Fair Labor Standards Act (“FLSA”) constituted a “wrongful act” under the terms of the defendant school board’s commercial general liability (“CGL”) policy, thereby reversing a decision by the United States District Court for the Western District of Virginia.


In Republic Franklin Insurance Company v. Albemarle County School Board, employees of the Albemarle County School Board (“Board”) filed an action against the Board alleging the Board had violated the FLSA by failing to pay them the overtime rate when they worked in excess of forty (40) hours a week. The Board tendered the defense of the underlying suit to its insurer, Republic Franklin Insurance Company (“Republic”).


Under the terms of the CGL policy issued by Republic to the Board, Republic agreed to "pay for all ‘loss’ resulting from a ‘claim’ for a ‘wrongful act’ to which this insurance applies." The policy defined "loss" as "any amount which an insured is legally obligated to pay as damages," and the term included coverage for punitive damages "where insurable by law." "Loss," however, did not include "fines or penalties imposed by law" or "operating costs of [the insured’s] institution such as would be included in [the insured’s] ‘educational institution’s’ budget. "The policy defined "wrongful act" as "any breach of duty, neglect, error, omission, misstatement, or misleading statement in the discharge of ‘educational institution’ duties."


Republic agreed to defend the underlying action with a reservation of rights to challenge coverage, and filed a declaratory judgment against the Board seeking a declaration that Republic owed no duty to defend the Board in the underlying action, and owed no duty to indemnify the Board for any judgment that might be entered in the underlying action. Specifically, Republic asserted that (1) FLSA violations were not “wrongful acts” as covered by the CGL policy Republic issued to the Board; and (2) that any judgment that might be entered against the board would no impose “losses” on the Board, as “loss” was defined in the policy. The Board counterclaimed for a declaratory judgment that Republic had a duty to defend the underlying action and a duty to indemnify the Board for the amount of any judgment that might be entered.


The parties filed cross-motions for summary judgment. The district court denied the Board’s motion and granted Republic’s motion, declaring that Republic owed no duty to defend or indemnify the Board, and finding that, inter alia, the FLSA complaint did not allege a “wrongful act.” The district court also found that because the claim for back wages was not a claim for “damages,” as required by the definition of loss, but rather an existing operating cost, the claim liquidated damages and attorneys’ fees was also not a loss “because that claim did not exist independently of the claim for back wages.”


The Board subsequently appealed the ruling of the district court, leaving the Fourth Circuit to decide two issues: (1) whether the underlying FLSA complaint alleged a claim for a wrongful act; and (2) whether liquidated damages and attorneys’ fees claimed because of the FLSA violations were losses covered by the policy.

Wrongful Act

With regard to the “wrongful act” issue, Republic argued the Board’s failure to comply with the FLSA could not be a wrongful act because the Board had a preexisting duty to comply with the FLSA, and contended that the Board’s obligation to pay wages arose as soon as the work at issue was performed and therefore could not constitute a later wrongful action covered by the policy.


Rejecting Republic’s argument, the Fourth Circuit found that, “while a preexisting duty might be relevant to whether an insured suffers an insurable loss, it cannot be relevant to whether the insured is the subject of a claim for a wrongful act.” The court further explained:

Every duty breached or violated is necessarily a preexisting duty, and it is the breach or violation of that duty which constitutes a wrongful act. And, this is precisely how the insurance policy in this case defines a wrongful act: "‘Wrongful act’ means any breach of duty, neglect, error, [or] omission.” In the underlying FLSA complaint, the employees allege that the School Board failed to pay them wages for all work done and for overtime work, in violation of the duties imposed by the FLSA. The School Board’s alleged failures are thus breaches of the duty imposed by the FLSA and therefore wrongful acts. By its plain language, the policy covers claims for the wrongful acts alleged in the underlying complaint.

(Emphasis in the original).

The court further noted that Republic’s argument “conflate[d] the concepts of ‘wrongful act’ and ‘loss’”:

Confusingly, [Republic] conflates the concepts of "wrongful act" and "loss," failing to recognize that a breach of a preexisting duty to pay is a wrongful act but that the resulting obligation to pay back wages may not be a loss resulting from that wrongful act. Such loss could only arise if the failure to fulfill the preexisting duty to pay wages caused "damages" apart from the back wages not paid. See Pacific Ins. Co. v. Eaton Vance Mgmt., 369 F.3d 584, 590-91 (1st Cir. 2004).

See also Macy Dep’t Stores v. Fed. Ins. Co., 305 F.3d 597 (7th Cir. 2002); Oktibbeha Cnty. Sch. Dist. v. Coregis Ins. Co., 173 F. Supp. 2d 541 (N.D. Miss. 2001). The court explained:

[A] judgment ordering an insured to pay money that the insured was already obligated to pay, either by contract or by statute, is not a "loss" covered under an insurance policy that requires that the loss be caused by a "wrongful act." The alleged "loss" in such cases arises from the contract or the statute itself, not from the failure to abide by it....[However, the rule is not] that the failure to comply with a preexisting duty cannot be a “wrongful act.” Such a rule would not only be incompatible with the definition of "wrongful act" in such policies—defined broadly to include "any breach of duty"— but also is counterintuitive because no violation of the law could ever be a "wrongful act" as there would always be preexisting duty to follow the law.

Accordingly, the court found that the underlying complaint alleged “wrongful acts” on the part of the Board within the meaning of the policy issued by Republic.

Losses

With regard to whether liquidated damages and attorneys’ fees claimed because of the FLSA violations were losses covered by the policy, Republic argued that the liquidated damages and fees were not covered losses because (1) they are inextricably connected with the claims for back wages and overtime pay, which are not losses; (2) they are "fines or penalties imposed by law" and therefore excluded under the policy; and (3) they are restitutionary in nature and therefore not "damages," as required by the policy’s definition of "loss." The Board disagreed and argued that unlike back wages, the liquidated damages and attorney’s fees were damages resulting from its alleged wrongful acts.

The Fourth Circuit rejected Republic’s argument and held that “because the underlying FLSA complaint .... demand[ed] not only back wages, but also liquidated damages and attorneys’ fees resulting from the School Board’s wrongful acts....any judgment against the School Board, to the extent it would include liquidated damages and attorneys’ fees, would amount to a ‘loss’...resulting from a claim for a ‘wrongful act.’” In so finding, the court relied on controlling Supreme Court precedent “holding that liquidated damages as authorized by the FLSA are not penalties, but rather, compensatory damages ‘for the retention of a workman’s pay which might result in damages too obscure and difficult of proof for estimate other than by liquidated damages.’”  (Quoting Brooklyn Sav. Bank v. O’Neil, 324 U.S. 697, 707 (1944)). Thus, the Fourth Circuit found that Republic’s policy provided coverage for the liquidated damages and attorneys’ fees as a loss, as defined by the terms of the policy.



Read More

Fourth Circuit Declines to Apply Tort Doctrine to Insurance Contract

Post by Jack Griffeth

Last Friday, February 3, 2012, the United States Court of Appeals for the Fourth Circuit [1] filed its opinion in Pennsylvania National Mutual Casualty Insurance Company v. Roberts, in which the Court declined to apply the tort doctrine of “joint and several liability” to the payment of insurance proceeds.

The underlying facts of this case are tragic.  From birth, Lakia Roberts was exposed to lead paint dust in the building where she lived.  She was first diagnosed with lead poisoning at only “20 months” of age.  The exposure to lead over the years resulted in debilitating problems.  A jury returned a verdict of $2,000,000 against Attsgood and Gordon Gondrezick who owned, leased and managed the property for the period of 55 months of lead exposure that Roberts suffered. Under the Maryland economic damages cap, the $2,000,000 judgment was reduced to $850,000.  It was undisputed that Attsgood and Gondrezick were jointly and severally liable for the $850,000.     

Pennsylvania National filed a declaratory judgment action against Attsgood and Roberts on the basis of diversity jurisdiction.  Penn National argued that it was obliged to indemnify its insured Attsgood for no more than 40% of the total judgment or $340,000.  It was undisputed that Attsgood had owned a policy of insurance for the property with Penn National for 24 months (January 1992 – January 1994), but Attsgood had sold the property to Defendant Gondrezick in November of 1993.  Penn National contended that it only had 22 months of coverage. 

There were cross motions for summary judgment filed in the District Court.  Plaintiff Roberts argued that Penn National owed the entire verdict based on “joint and several” liability.  Penn National argued that it owed for only 22 months of coverage given that during the last two months of coverage, its insured did not own the property.  The lower Court held Penn National to an exposure of 24 months, the entire period of coverage, but refused to impose a “joint and several” recovery.  Both parties appealed.  The Fourth Circuit affirmed in part and reversed in part as follows:

1. The Court recognized the tragic circumstances that Roberts had suffered but adhered to the plain language of the insurance contract which obligated Penn National, on behalf of Attsgood, to pay sums legally obligated to pay as damages because of “bodily injury…to which this insurance applies…”
2. The Court reasoned that since Attsgood did not own the property for the last two months of the Penn National coverage period that Penn National’s pro rata share amounted to 22 of the 55 months exposure (40%) of the amount of the underlying verdict.  
3. In rejecting the “joint and several” tort analysis, the Fourth Circuit in its well reasoned opinion noted that Attsgood and Gondrezick were jointly and severally liable and that each was responsible for the entire judgment under long standing principals or tort law.  However, the court held that insurance coverage disputes are “governed by contract law…” and the court could therefore find no rationale to support the imposition of “joint and several” liability upon the insurer.  Moreover, the court held that though there was a distinct and full basis of Maryland cases to support this position, it further opined that not only was it “neither equitable or fair to require an insurance company to pay for coverage during the period for which effective coverage was not in force,” but would be disruptive for insurance markets as well.  Ultimately, the Court reasoned that such a “joint and several” application would, in fact, ultimately, discourage tort feasors from buying insurance, and would create uncertainty which would result in significant costs on both insurance companies and policy holders.

Conclusion:

In recognizing that Roberts, unfortunately, might not be able to collect the full amount of the $850,000 judgment, the Fourth Circuit, nevertheless, upheld the principle that it could not ignore the Maryland law by holding an insurance company to a contractual provision, in which it never agreed to, or to scramble together whole areas of the law that are conceptually distinct.     

---

[1] Including the Honorable Richard M. Gergel, United States District Judge for the District of South Carolina, sitting by designation.

Read More