Can You Settle Your Third-Party Claim While in Coverage Purgatory?

P. Wesley Lambert | Brouse McDowell | November 13, 2017

Most commercial general liability (CGL) policies grant control over the defense and settlement of third party claims to the insurer. Thus, the right to settle, or not settle, a third-party claim against the policyholder resides with the insurer. However, when an insurance company breaches its policy, for example by wrongfully refusing its duty to provide a defense to its policyholder, the policyholder may settle the claim against it without securing the insurer’s consent. Sanderson v. Ohio Edison Co., 69 Ohio St. 3d 582, 635 N.E.2d 19 (1994). Conversely, when the insurance company is honoring its defense obligation, even under a reservation of rights to later contest coverage, the policyholder must respect the policy’s grant of control of the settlement process to the insurer or risk losing coverage for any settlement reached without the insurer’s consent.

But, what happens when the insurer is providing a defense to the insured, and thus technically complying with the policy’s terms, yet has made it clear that it will not actually indemnify the policyholder for any settlement or judgment? These situations leave the policyholder in a sort of coverage purgatory – it is receiving the defense coverage it bargained for, but not the indemnity coverage. Policyholders may want to resolve the claims against them in order to limit their liability, but may also be afraid that doing so will result in a forfeiture of coverage for the settlement amount.

Fortunately, courts have constructed an alternative path for policyholders stuck in these situations, holding that insures may not leave their policyholders in limbo by controlling the policyholder’s defense but unequivocally refusing to indemnify the policyholder for any settlement or judgment. In Ward v. Custom Glass & Frame, Inc., 105 Ohio App.3d 131 (8th Dist. 1995) and Patterson v. Cincinnati Ins. Cos., 2017-Ohio-2981, 2017 WL 2291605 (8th Dist. Aug. 22, 2017), the Eighth District Court of Appeals held that when an insurer clearly indicates that it will not indemnify the policyholder, the policyholder is relieved from the obligation to secure the insurer’s consent prior to settling the claim against it.

In both cases, the policyholder was subject to a third-party claim that the insurer had agreed to defend. However, the insurer in both cases stated, in no uncertain terms, that it would not indemnify the policyholder if there were a judgment against it. Thus, the insurance companies maintained that they had the right to control the policyholder’s defense, and its ability to settle the claim, but that it would not actually fund any settlement or ultimate judgment. The policyholder, left with no other option, settled the claim itself, while at the same time keeping the insurer apprised of the settlement negotiations.

The insurers in both cases argued that the policyholder’s disregard of the policy’s consent to settle provision relieved the insurers from the obligation to cover the settlements. Both courts disagreed. The Ward court was particularly critical of the insurer’s conduct, holding that “[w]hen an insurance company refuses to provide coverage and at the same time seeks to maintain control of the same litigation, it . . . creates a frustration of purpose. Such conduct would compel a person of reasonable faculties to cut his costs and settle a lawsuit to avoid the possibility of a higher judgment.” Ward, 105 Ohio App.3d at 137. Thus, when an insurance company maintains that coverage does not exist, it “must make a clean break from the case and should not subject the insured to a guessing game or by its conduct cause the insured to incur more expenses than necessary.” Id. The Patterson similarly noted the “frustration of purpose” created when the insurer controls the defense of an action while at the same time disclaiming its duty to indemnify. Patterson, 2017-Ohio-2981 at ¶30.

Thus, policyholders trapped in coverage purgatory may look to Ward and Patterson for support when deciding whether they may settle a case against them without violating their policy’s consent to settle provision. It is important to note, however, that in both cases the policyholder kept the insurer apprised of the settlement negotiations and offered them the opportunity to remain involved in the process. While it is unclear whether this impacted the courts’ analysis of the case, policyholders would be well-advised to keep the lines of communication open with their insurer despite the ostensible breach of the policy’s indemnification obligation.

NJ Courts Continue Expansion of Insurance Coverage for Construction Defects: “Continuous Trigger” Doctrine Applied

Adam J. Sklar | Property Insurance Coverage Law Blog | October 25, 2017

New Jersey courts are continuing their trend of extending insurance coverage for third-party construction defect claims. Following last year’s NJ Supreme Court decision in Cypress Point Condo. Ass’n, Inc. v. Adria Towers, LLC, 226 N.J. 403 (2016), which broadly interpreted the standard CGL policy to extend an insured developer’s coverage to include claims of damage caused by the work of subcontractors, the New Jersey Appellate Division recently issued a published decision approving a trial court’s use (though not its application) of the “continuous trigger” theory of insurance coverage to third-party construction defect claims, thereby, potentially extending coverage in such cases over multiple policy years.

In Air Master & Cooling, Inc. v. Selective Insurance Co., A-5415-15T3 (N.J. App. Div. October 10, 2017), the Appellate Division reviewed a trial court’s decision in a declaratory judgment action filed by a subcontractor against two of its insurers. Those insurers had declined coverage and refused to defend the subcontractor in a construction defect litigation filed by the condominium association (the “Association”), on whose 101-unit building the subcontractor had performed certain HVAC work on the roof and in each individual unit. The Association and certain unit owners claimed damage due to progressive water infiltration, which they attributed to defective workmanship, and the subcontractor was joined in the litigation as a third-party defendant.

The subcontractor had performed work at the building from November 2005 through April 2008. In early 2008, unit owners began to notice water infiltration into their units and resulting damage. A newspaper article published 2010 detailed the 2008 discovery of leaks by the unit owners. In May 2010, the Association’s consultant issued a report identifying certain areas of the roof in need of replacement though noting it could not determine when the infiltration had occurred.

The subcontractor had three insurers from 2005 through 2015. The insurer for the period November 2005 through June 2009, agreed to defend the subcontractor under a reservation of rights, as it was the insurer during the period the work was performed and at the time the first water infiltration was alleged to have been discovered. The next insurer, Selective Insurance, provided coverage from June 2009 through June 2012, and disclaimed coverage, on the basis that the property damage was alleged to have manifested before the policy periods had begun. The third insurer, with coverage from June 2012 through June 2015, also disclaimed coverage, and was dismissed from the subcontractor’s declaratory judgment case, without appeal, on the basis that its 2012 coverage commenced long after any leaks had started and any resulting damage manifested.

After some discovery was conducted, Selective moved for summary judgment, which was granted by the trial court. The trial court applied the continuous trigger doctrine of insurance coverage in analyzing whether Selective owed the subcontractor a duty to defend the construction defect claim. It determined conclusively, however, that the damage to the building had manifested itself before Selective’s June 2009 coverage began.

On appeal, the Appellate Division, while agreeing that the continuous trigger doctrine was applicable in the construction defect context, disagreed with the ultimate determination – or at least found that the record was not sufficiently developed to make that determination. The appellate court, therefore, reversed the judgment in favor of Selective and remanded the case back to the trial court with guidance on the application of the continuous trigger doctrine in the construction defect coverage context.

The continuous trigger effectively grants continuous coverage to an insured in connection with a third-party damage claim from the date of the initial exposure to the harm through the date of the manifestation of the injury resulting from the harm. The appeals court rejected the subcontractor’s attempt to extend the doctrine even further to extend to the date of “attribution” – that is, when the particular damage could be attributed to a particular insured. Doing so would be akin to transforming policy to claims made policy from occurrence-based, and likely escalate premiums or deter policies from being written. Instead, the court determined that the endpoint of the coverage, or manifestation (or “last pull of the trigger”), should be the date when the harm has sufficiently become apparent or manifests itself to trigger a covered occurrence.

The Appellate Division, guided by the precedential first-party coverage case, Winding Hills Condo Ass’n v. North American Specialty Ins. Co., 332 N.J. Super. 85 (App. Div. 2000), held that the manifestation occurs at that time of the “essential” manifestation of the injury, and not necessarily at the initial discovery of the injury. The essential manifestation is “the revelation of the inherent nature and scope of that injury.” In examining whether the May 2010 report (during Selective’s policy period) or 2008 unit owner observations of water infiltration (before Selective’s policy period) should be used as the manifestation or end date of coverage, the court found the record too sparse to make that determination. There were no depositions, or other evidence, revealing who knew what and when about these construction defects, and the court refused to rely on hearsay statements of the unit owners in the newspaper article.

Accordingly, the court remanded the case back to the trial court for a determination of what information about the building defects at issue were or reasonably could have been revealed between the time of the unit owner complaints and the start of Selective policy in June 2009. The appeals court also noted that the matter was further complicated by the fact that the water infiltration associated with the roof was not discovered until the May 2010 expert report, while the newspaper article does not mention the roof. Thus, there were genuine issues of material fact as to, among other issues, when water infiltration problems on the roof first became known or reasonably could have been known.

The Air Master decision continues a trend in New Jersey jurisprudence of expanding, within reason, CGL coverage to insureds. In particular, in construction defect cases, the courts have recently liberally interpreted policies and legal theories to afford more coverage to insureds. Where construction defects cause progressive property damage, as in the common case of water infiltration, Air Master will help to guide insurers, insureds and their respective counsel in analyzing whether, based on the facts alleged by a third-party, coverage is available for particular policy years. It is also likely to spawn additional discovery and expense in the underlying construction defect cases specific to those issues.

Property Damage, Occurrences, Delays, Offsets and Fees. California Decision is a Smorgasbord of Construction Insurance Issues

Garret Murai | California Construction Law Blog | November 13, 2017

I read once that 97 percent of cases never go to trial. However, there are still the ones that do. And, then, there are the ones that do both. The following case, Global Modular, Inc. v. Kadena Pacific, Inc., California Court of Appeals for the Fourth District, Case No. E063551 (September 8, 2017), highlights some of the issues that can arise when portions of cases settle and other portions go to trial, the recovery of delay damages on a construction project through insurance, and the recovery of attorneys’ fees.

Global Modular, Inc. v. Kadena Pacific, Inc.

The U.S. Department of Veterans Affairs contracted with general contractor Kadena Pacific, Inc. (Kadena) to oversee construction of its Center for Blind Rehabilitation in Menlo Park, California. Kadena, in turn, contracted with subcontractor Global Modular, Inc. (Global) to construct, deliver and install 53 modular units totaling more than 37,000 square feet for a contract price of approximately $3.5 million.

Because Kadena had contracted with another subcontractor to install the roofing, Global agreed to deliver the units covered only by a roof deck substrate comprised of a three-quarter inch sheet of plywood. Delivery of the units was originally scheduled for the summer, however, due to project delays the units were not delivered until October and November.

Well, you can guess what happened.  The rains came and the units were damaged.

The Kadena-Global subcontract provided that Global would assume responsibility “for any loss or damage to the [units] . . . however caused, until final acceptance thereof by [Kadena].” The contract conditioned “final acceptance” upon the VA’s approval of the units. Kadena, however, as the general contractor, was responsible for the overall project schedule.

When Global refused to pay Kadena, Kadena sued, and Global countersued for the water damage. Before trial, the parties entered into a partial settlement. Global paid Kadena $321,975 except for claims covered by Global’s insurance policy with North American Capacity Insurance Company (NAC) and Global received $153,025 to dismiss  its failure-to-pay claims. At trial, Kadena presented evidence of its cost to repair the water damage and was awarded approximately $1 million.

In a separate action brought by NAC, Kadena and NAC filed competing motions for summary judgment on the issue of whether NAC’s policy required it to indemnify Global for the approximately $1 million award in the other action. The trial court ruled in favor of Kadena finding that the award was covered under the NAC policy. The trial court also ruled that the award should be offset by the $321,975 Global paid in settlement and that Global was liable to Kadena for $360,000 in attorneys’ fees.

NAC, Kadena, and Global each appealed, with: (1) NAC arguing that the water damage was not covered under its policy; (2) Kadena arguing that $321,975 settlement paid by Global should not be offset; and (3) Global and NAC arguing that the $360,000 in attorneys’ fees should not have been awarded to Kadena.

Messy enough for you?

The Appeal

NAC’s Argument That the Water Damage was Not Covered Under its Policy

On appeal, NAC, Global’s insurer, argued that the water damage was not covered under its policy. Typical of commercial general liability insurance policies, the policy covered “property damage” caused by an “occurrence,” which was defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” From this broad occurrence-based coverage, the policy carved out a variety of exclusions.

One of those exclusions (Exclusion j(5)) excluded coverage for “[t]hat particular part of real property in which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the ‘property damage’ arises out of those operations.” NAC argued that the phrase “are performing operations,” refers to works in progress and that the exclusion applies when property damage occurs before construction is complete and, because Global had not yet completed installation of the units, the exclusion applied. Global, on the other hand, argued that the phrase “are performing operations” only applied to particular components Global was physically working on at the time of the property damage and, because the water intrusion occurred while Global  was not working on the units, the exclusion did not apply.

Another exclusion (Exclusion j(6)) excluded coverage for “[t]hat particular part of any property that must be restored, repaired or replaced because ‘your work’ was incorrectly performed on it.” NAC argued that, because Global inadequately waterproofed the units, Global’s “work” was “incorrectly performed” and the exclusion applied. Global, on the other hand, argued that the term “work” refers to a product, such as warped or uneven floors, not to a process like covering units with plastic tarps, and that even if its waterproofing efforts were ineffective, the “particular part” of the “work” that was “incorrectly performed” was the use of a plywood substrate not the interior parts of the units.

While acknowledging NAC’s argument that commercial general liability insurance policies “are not designed to provide contractors and developers with coverage against claims their work is inferior or defective,” the Court of Appeal stated, “[t]he problem with NACs’ argument is that it is based on its view of the underlying policy of commercial general liability insurance and not on an application of the policy language to the facts of the case.” And, here, tarping the units, even if performed incorrectly or inadequately was not a part of Global’s “work.”

With respect to Exclusion j(5), the Court of Appeals concluded that the active, present tense construction of the policy language, “are performing operations,” indicated that the exclusion only applies to damage caused during physical construction activities and, because Global was not physically working on the units at the time of the water damage, the exclusion did not apply. With respect to Exclusion j(6), the Court held that the “only arguably defective components or parts of Global’s work are the plastic tarps, as they failed to keep the water out,” but “more importantly, there was no allegation the items for which Kadena sought repair and replacement costs – the drywall, insulation, framing, and ducting – were defective” (emphasis in original).

Result: Win for Global.

NAC’s Argument That Delay Damages Were Not Covered Under its Policy

On appeal, NAC further argued that the delay damages awarded for the 131 days Kadena spent remediating the water damage were not covered under its policy because it did not constitute “property damage.”

The Court of Appeal disagreed stating, “contrary to NAC’s contention, delay damages arising from “property damage” fall under the insuring clause, which obligates NAC to ‘pay those sums that the insured becomes legally obligated to pay as damages because of . . . . ‘property damage’ to which this insurance applies’” (emphasis in original). While the policy does not define damages, held the Court, “courts generally interpret the term to mean payments made to compensate a party for direct and consequential injuries caused by the acts of another” and “[h]ere, the 131 days of remediation was time Kadena could have spent completing the project had the units’ interiors not been damaged. That delay constitutes a consequential loss (a loss occasioned by the water intrusion) and as such, is part of the damages NAC must pay ‘because of’ property damage.”

Result: Win for Global.

Global and NAC’s Argument that Attorneys’ Fees Were Not Recoverable by Kadena

On appeal, NAC and Global argued that attorneys’ fees were not recoverable by Kadena because Kadena had released its right to obtain attorneys’ fees under the terms of its settlement with Global.

Under Code of Civil Procedure sections 1033 and 1033.5, explained the Court of Appeals, attorneys’ fees can be claimed as costs if allowed under law or statute. Further explained the Court, the Kadena-Global subcontract included an attorneys’ fee provision stating that Global “expressly agrees” to pay the reasonable attorneys’ fees Kadena incurs in “enforcing any provision or obligation arising under the contract.” This provision, while a one-way attorneys’ fee provision permitting only Kadena to recover attorneys’ fees, became bilateral under Civil Code section 1717, which provides:

In any action on a contract, where the contract specifically provides that attorney’s fees and costs, which are incurred to enforce that contract, shall be awarded either to one of the parties or to the prevailing party, then the party who is determined to be the party prevailing on the contract, whether he or she is the party specified in the contract or not, shall be entitled to reasonable attorney’s fees in addition to other costs.

Because the settlement agreement was intended to resolve all of the parties disputes except for claims NAC would cover, the agreement obtained two provisions, one releasing “all claims” arising from the VA project and another carving out a limited subset of claims arising from the VA project that the parties were reserving for trial:

4.1.1 Notwithstanding the language of Civil Code section 1542 and waiver provided in Section 4.2 of this Agreement, it is the parties’ express intent and they so agree that this agreement does not release claims from the Project related to  property damage, personal injury, [loss] of use and other claims that are covered under the [NAC] insurance policies described in Section 4.9.1 of this Agreement, true and accurate copies of which are attached to this Agreement as Exhibits “A” and “B”

(emphasis in original).

Based on this language, held the Court of Appeals, the settlement agreement allows Kadena to pursue its water damage claim and, as the prevailing party, to seek attorneys’ fees as part of that claim.

Result: Win for Kadena.

Kadena’s Argument that the $321,975 Settlement Paid by Global Should Not be Offset

Finally, on appeal, Kadena argued that the $321,975 settlement paid by Global should not offset the $1 million damage award covered by NAC’s policy because the payment represented payment in exchange for Kadena’s release of claims other than its water damage claim. In support of its argument, Kadena pointed to the Kadena-Global settlement agreement, which provided that the parties were agreeing to release all claims against one another except for claims from the project “related to” claims covered by NAC’s policy.

“The equitable concept of offset,” explained the Court of Appeals, “recognizes it is unfair to require a defendant to compensate a plaintiff twice for the same injury.” “Thus, to warrant offset, Global’s settlement payment to Kadena must have compensated Kadena for the same harm as the jury’s damage award.” But here, held the Court, the jury was instructed by the trial court that any awarded damages should be limited to damages related to water remediation only and not to defective workmanship or pre-rain delays.

Result: Win for NAC.

Isn’t it nice when everyone’s a winner?

Conclusion

Global Modular underscores that, while commercial general liability policies are not intended to serve as a warranty covering poor workmanship, they do cover “property damage” that “occurs” from poor workmanship. Further, the case clarifies that delay damages may be recoverable depending on the language of the insurance policy. And, finally, the case serves as a reminder that when settling portions of a case, it is important to be clear what specific portions of a case are being settled, as parties may not seek damages for those settled portions, or an offset may apply.

If You Believe Your Appraisal Award Is Wrong – You Might Be Right

Jeff Zane | Property Insurance Coverage Law Blog | November 13, 2017

In theory, the appraisal process is intended to provide an efficient means of determining the cost to repair or replace damaged property. It is also intended to have a degree of finality – once the appraisal panel determines the amount of damages, the damages are typically fixed at that amount.

However, that does not mean you shouldn’t examine an appraisal award, or that you necessarily must accept it if it is substantially defective. In Texas, as in many states, an appraisal award may be set aside: (1) when the award was made without authority; (2) when the award was made as a result of fraud, accident, or mistake; or (3) when the award was not in compliance with requirements of the policy.1

If your appraisal award seems incorrect to you, try to obtain as much information as you can about the basis for the award. This is not always easy, because appraisal panels can be less than transparent about their reasoning and methods. For this reason, it is sometimes important that your appraiser attempt to memorialize as much as is possible about the panel’s deliberations through emails, notes or other contemporaneous records.

It may be possible to set aside an appraisal award, for example, if the panel improperly bases its award on repairs or replacement with materials that are not like kind and quality with the existing property.

To explain, most insurance companies promise in their policies they will repair or replace damaged property with materials of “like kind and quality.”2 Notwithstanding this clear language, a carrier’s appraiser may coax an umpire to reduce the amount of an award by basing it upon the cost to use a materially different roofing system. Perhaps the carrier feels that a 90-millimeter roof can be replaced by a 45-millimeter roof, or that premium tiles may be replaced by lower-grade tiles with a more limited life-span. Arguably, neither example represent materials of “like kind and quality.”3

If this happens, you might consider challenging the appraisal award because the appraisal panel has exceeded its powers by failing to comply with the terms of the underlying contract. Appraisal panels enjoy a good deal of discretion, but they do not enjoy the unfettered ability to stray from the governing insurance policy. If an appraisal award is “not in compliance with the requirements of the policy” because it does not comply with the “like kind and quality” provision, then a court should reject the award.

Challenging an appraisal award is always an arduous task, however, and you will want to consider your options carefully. If you have any doubts about your award, be sure to speak with an experienced attorney.
____________________
1 Garcia v. State Farm Lloyds, 514 S.W.3d 257, 265 (Tex. App. 2016), review denied (June 2, 2017). See also Hanson v. Commercial Union Ins. Co., 150 Ariz. 283, 285, 723 P.2d 101, 103 (Ariz. App. 1986) (“An award must comply, in substance and form, with the submission agreement. Thus, the act of an umpire in excess of his authority renders the award void, to the extent that the authority is exceeded. And the same result is reached, whether the authority is exceeded consciously or by mistake. Appraisers’ acts in excess of authority are not binding on the parties, without ratification.”).
2 The standard Texas homeowner’s policy, for example, provides that the insurance company will “repair or replace any part of the damaged property with material or property of like kind and quality.”
3 I also urge you to read – or re-read – my colleague Jonathan Bukowski’s excellent post regarding “matching” issues in an appraisal award in a recent Colorado case.

Bad Faith Claim Handling – How to Avoid it Without Simply Paying All Insurance Claims

A. David Fawal | Butler Snow | November 7, 2017

“Bad faith” – just the sound of it can bring fear to even the most experienced claim adjuster. And for good reason. In many states, an allegation of bad faith in claim handling or a claim decision can bring with it the threat of punitive or exemplary damages.  The standard by which bad faith is judged varies, with some states imposing statutory liability, while in other states it is a judicial creation. Claim handlers could be forgiven for believing the only way to avoid a bad faith lawsuit is to simply pay all claims regardless of merit, but I submit there is another way. And having a good “bedside manner” is a start.

Having defended hundreds of bad faith lawsuits over the years, I have noted a common theme. I call it “bedside manner”, similar to what you expect from your doctor.  In the vast majority of bad faith lawsuits I have seen, there is almost always some communication failure between the claim handler and the insured, with the insured coming away feeling as if the adjustor is ignoring the insured, or worse, doesn’t care. Keeping the insured informed through every step of the process is a good practice to follow. While it is true that denying an insured’s claim is never good news for an insured, responsiveness, compassion and understanding by the adjuster toward the insured can go a long way to alleviating the ill will that sometimes leads to a bad faith claim.

Practicing good customer relations is not the only way to avoid bad faith. Another pointer is to be sure to know the applicable insurance policy inside and out. Lack of familiarity with the insuring agreement, conditions or exclusions tends to manifest itself in confusion and frustration on the part of the adjuster and the insured, sometimes leading the insured to lack confidence in any claim decision being explained.

While bad faith is most typically associated with claim denials, many states also recognize bad faith investigation. It goes without saying (but I’ll say it anyway), that the best way to avoid a claim of bad faith investigation is to …. you guessed it …. investigate. If the claim file does not contain the factual basis to support the claim decision, chances are an adequate investigation has not been conducted, or if conducted, has not been documented. But it is not enough to simply conduct an investigation into the claim – there should also be a review and evaluation of that investigation before a decision is made, and the claim file should reflect that review and evaluation.

Which brings us to another tip for avoiding bad faith – documenting the file.  There is an old mantra that says “if it isn’t noted in the claim logs, it didn’t happen.” That is a good mantra to keep in mind.  Claim activity should be noted in the file, to support the decision made and the basis for it. It is much easier to point to notes in the file showing what was done than to try and recall things that are not documented and try to explain years later that certain things were actually done during the investigation, but not noted in the file. Of course, when entering claim notes, assume that everything in the claim file will be revealed for courtroom scrutiny. Use detailed, accurate and courteous entries in the daily log and in all reports and avoid unnecessary editorial, careless or harsh comments.

Paying claims regardless of merit is not the solution. In the end, prompt, courteous and accurate communications with the insured are paramount. It may not be possible to always avoid a bad faith claim, but remembering a few of these pointers could go a long way in that direction.