Under the so-called “notice-prejudice Rule” applicable in some jurisdictions, insurers can deny coverage for claims based on the policyholder’s late provision of notice of claim only in the event that the late notice materially prejudiced the insurer. In a recent decision, the California Supreme Court, ruling on questions certified to the Court from the Ninth Circuit, held that the notice-prejudice rule represents a “fundamental public policy” under California law potentially sufficient to override the choice of law provision in the parties’ insurance contract. The Court also held that the notice-prejudice rule also applies to the consent to incur expense provisions in first-party insurance policies. As discussed below, there are a number of interesting aspects to the court’s ruling. The California Supreme Court’s August 29, 2019 decision in Pitzer College v. Indian Harbor Insurance Company can be found here.
Pitzer College discovered contaminated soil on a location on which it had planned to build a dormitory. The College undertook site remediation work in March 2011, which it successfully completed one month later at a total cost of $2 million.
The College maintained an environmental remediation insurance policy. However, the College did not obtain the insurer’s consent before commencing remediation or paying the remediation costs. Indeed, the College did not inform the insurer of the remediation until July 2011, three months after the remediation was completed and six months after the College detected the contamination.
The insurer denied coverage for the college’s remediation costs based on the College’s failure to provide timely notice of claim and failure to obtain the insurer’s consent for the remediation costs. The College initiated an action for declaratory relief and for breach of contract. The insurer filed a motion for summary judgment, which the district court granted.
The district court, applying New York law in light of the choice of law provision in the college’s insurance policy, held that summary judgment was warranted because the College did not provide timely notice of claim. The district court held that under New York law the insurer did not have to show that it was prejudiced by the late notice. The district court also held that summary judgment was separately warranted because the college did not comply with the Policy’s consent provisions before incurring the remediation expenses. The College appealed the district court’s ruling.
On appeal, the College argued under relevant choice of law principles that because the notice-prejudice rule represents a “fundamental public policy” in California that the district court should have applied California law to the late notice issue, rather than New York law, notwithstanding the provision in the policy designating the law of New York law to be applied to policy interpretation.
The August 29, 2019 Opinion
In an August 29, 2019 Opinion written by Justice Ming Chin for a unanimous court, the California Supreme Court ruled, “in line with California’s strong preference to avoid technical forfeitures of insurance policy coverage,” that the state’s notice-prejudice rule is a “fundamental public policy,” and that the notice prejudice rule applies to consent provisions in the context of first party liability coverage.
In reaching these determinations, the Court first noted that under applicable choice of law principles, the parties’ contractual choice of law provision generally governs unless it conflicts with the state’s fundamental public policy and the state has a materially greater interest in the determination of the issue than the contractually chosen state.
The Court then noted that California’s notice prejudice rule requires an insurer to prove that the insured’s law notice of a claim “has substantially prejudiced the ability to investigation and negotiate payment of the insured’s claim.”
In considering the question of whether the notice prejudice rule represents a fundamental California public policy, the Court considered the three reasons for establishing the rule.
First, the rule overrules the parties express intentions in a defined notice term, “preventing a technical forfeiture of insurance benefits unless the insurer can show that it was prejudiced by the insured’s late notice.”
Second, the notice prejudice rule “protects insureds against inequitable results that are generated by insurers’ superior bargaining power.”
Third, the rule “promotes objectives that are in the general public’s interest because it protects the public from bearing the costs of harm that an insurance policy purports to cover.”
Based on these considerations, the Court concluded that California’s notice-prejudice rule is “a fundamental public policy of California,” because the notice requirement “serves to protect insurers from prejudice, not to shield them from their contractual obligations through a technical escape-hatch.”
But while the Court concluded that the notice-prejudice rule represents a fundamental California public policy, the question under applicable choice of law principles as to whether or not the California notice-prejudice rule applies depends on the determination of the further question of whether or not California has a “materially greater interest” than New York in determining the coverage issue. The California court left it to the Ninth Circuit (and presumably to the district court) to determine which state has the materially greater interest, in order to conclude whether California rather than New York law applied.
In determining, under the second question certified by the Ninth Circuit, whether the notice-prejudice rule applies to the policy’s consent provisions, the California court first noted that the same rationale for the application of the notice-prejudice rule to the policy’s notice provisions apply to the policy’s consent provisions. The Court observed that “at core,” the “purposes” of the consent provisions are the same as with respect to the notice provisions; they both “facilitate the insurer’s primary duties under the contract and speaking to minimizing prejudice in performing those duties.”
In considering these issues, the Court drew a distinction between first-party insurance policies and third-party insurance policies. The Court noted that because of third-party insurer’s right to control the defense and settlement of claims, California’s appellate courts have generally refused to find the notice-prejudice rule applicable to consent provisions in third-party policies. By contrast, in first party policies, the insurer’s duty to defend and settle claims is not crucial to the insurer’s coverage obligation, and the insurer does not exercise the same contractual control over the potential loss.
For these reasons, the Court said, “failure to obtain consent in the first party context is not inherently prejudicial, and the usual logic of the notice-prejudice rule should control.” The Court held that the notice-prejudice rule is applicable to a consent provision in a first-party policy “where the coverage does not depend on the existence of a third party claim or potential claim.”
However, the parties disagreed whether the policy involved in this dispute provides first-party coverage or third-party coverage. The Court said that the resolution of this question is beyond the scope of the questions certified by the Ninth Circuit, and therefor the Court left it to the Ninth Circuit to determine what type of policy is at issue.
While the California Supreme Court’s determinations on the certified questions unquestionably are beneficial to the interests of policyholders, it remains to be seen whether or not Pitzer College ultimately will benefit from the Court’s determinations.
On the late notice issue, the College will be able to rely on California’s notice-prejudice rule only if it is able to show in subsequent proceedings that California has a “materially greater interest” than New York in the determination of the issue.
On the consent to incur expenses issue, the College will be able to argue that the notice-prejudice rule applies only if it is able to establish in subsequent proceedings that the policy at issue is a first-party policy rather than a third-party policy.
And of course, even if the college establishes that the notice-prejudice rule applies to these issues, the college will only prevail if it is established that the late notice and failure to obtain consent did not prejudice the insurer’s interests.
Just the same, the California Supreme Court’s determinations will be useful to other policyholders. First and foremost, the California Court’s determination that the notice-prejudice rule represents a “fundamental public policy” of the state underscores the significance of notice-prejudice principles, which should add weight to the policyholder’s arguments opposing insurer’s efforts to try to deny coverage based on the alleged late provision of notice of claim.
The California Court’s determinations of the certified questions are also helpful for policyholders opposing late notice defenses because of what the Court said about the reasons for the notice-prejudice rule under California law. The rule, the Court said, is consistent with the state’s “strong preference to avoid technical forfeitures of insurance policy coverage.” This preference under state law to avoid forfeitures represents a substantial basis on which to oppose late notice defenses and other procedural defenses to policy coverage.
That said, there are also limitations on the usefulness to policyholders of the California Court’s determinations on the certified questions. For example, the California Court’s determination that the notice-prejudice rule applies to the policy’s consent provisions is limited with respect to first party policies only; this aspect of the Court’s determinations would not be helpful to policyholders seeking coverage under third-party liability policies.
There is a further aspect of the Court’s analysis that I think is worth further consideration. That is, that the Court’s determinations on the notice of claim issue in effect holds that the importance of the notice-prejudice rule under California law is sufficient that it could in effect override the choice of law provisions in the policy.
As a general matter, I am not a big fan of extra-contractual principles that negate bargained-for provisions in parties’ insurance contracts. On the other hand, I have also recognized that applicable legal principles are of course incorporated into all contracts. My concern about the application of these general principles is usually couched in terms that if these principles are going to be applied to override express policy provisions, the principles should be narrowly applied.
In that regard, I think it is noteworthy that the California Supreme Court ultimately did not determine that the fundamental California public policy regarding the notice prejudice rule overrode the choice of law provision in the parties’ contract; indeed, with respect to both certified questions, the Court said that there are still remaining issues of fact (or perhaps mixed issues of fact and law) that need to be determined in order to conclude whether or not the notice prejudice rule did or did not in fact apply to either the notice of claim issue or the consent issue.
There are two other considerations that are worth addressing whenever late notice and notice-prejudice issues come up. First, while there are considerations on which policyholders can seek to rely to try to argue that their late provision of notice should not preclude issue, the more important point is that well-advised policyholders will seek to implement procedures and practices to try to avoid the late provision of notice in the first place. Second, it is increasingly common at least in the D&O insurance context for provisions to be incorporated directly into the policy specifying that the insurer will not seek to deny coverage based on the late provision of notice unless the insurer can show that the late notices caused the insurer material prejudice. Both of these considerations represent important means by which policyholder can try to protect themselves from the kinds of conflicts that this insurance dispute represents.
I know for many readers, issues relating to choice of law principles can seem obscure. However, as I have noted in recent posts (for example, here), the court’s determination of which jurisdiction’s law applies can be outcome determinative. In addition, the authors of a recent guest post criticized the Delaware courts for asserting that their state’s laws apply to coverage disputes to which traditional choice of law principles arguably would have suggested that the laws of a different jurisdiction can apply. The fact is that while choice of law issues may seem obscure, they can prove to be very important in the context of insurance coverage disputes.
The obvious remedy to address the possibility of disputes over the choice of law applicable to insurance policy coverage questions is for the parties to the policy to include a choice of law provision in their policy. As this insurance coverage dispute shows, there may be limitations to how much parties may be able to accomplish by including a choice of law provision. As I alluded to above, there is a larger dispute here about whether, when, and to what extent extra-contractual legal principles should override expressly bargained-for policy provisions.
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Eleventh Circuit Holds That A Single Text Message Does Not Satisfy Injury In Fact Requirement for Standing Under the TCPA
Many children, including myself, were taught the childhood mantra: “Sticks and stones may break my bones, but words will never hurt me.” The chant intended to be a retort to name calling—a declaration that you were above the insults. But what about text messages? Could a single text message hurt me in a way that could amount to the harm required to sustain a Telephone Consumer Protection Act (TCPA) claim? On August 28, 2019, the Eleventh Circuit answered this question in the negative with its decision in Salcedo v. Hanna, — F. 3d –, 2019 U.S. App. LEXIS 25967 (11th Cir. Aug. 28, 2019). With Salcedo, the Eleventh Circuit created a potential circuit split by finding that a plaintiff could not rely on a single text message to amount an injury in fact necessary to establish Article III standing for a TCPA action.
The plaintiff filed a TCPA suit after having received a single multimedia text message from his former attorney and that attorneys’ law firm offering a ten percent discount on future services. The Plaintiff alleged this lone message caused him harm by (1) wasting his time during which both he and his phone “were unavailable for otherwise legitimate pursuits,” and (2)”resulted in an invasion of [his] privacy and right to enjoy the full utility of his cellular device.” The Eleventh Circuit rejected both arguments.
The appellate court found that its Circuit precedent holding a single fax sufficient to establish injury in fact inapplicable, distinguishing the purported harms associated with receiving a single text message from that of receiving a single fax. Unlike a fax, the Eleventh Circuit found no “tangible costs such as the consumption of paper and ink or toner to establish injury in fact” associated with a text message. Further, the Court also held that while receiving a fax creates “intangible costs” of wasted time and lost opportunity, receipt of a text message creates no such intangible costs as it “consumes the device not at all.” And as to phone calls, the court found that “Congress’s legislative findings about telemarketing suggest that the receipt of a single text message is qualitatively different from the kinds of things Congress was concerned about when it enacted the TCPA. In particular, the findings in the TCPA show a concern for privacy within the sanctity of the home that do not necessarily apply to text messaging.” Indeed, “cell phones are often taken outside of the home and often have their ringers silenced, presenting less potential for nuisance and home intrusion.” Differentiating text messages from calls (even calls to cell phones), the court held “[o]n text messaging generally, then, the judgment of Congress is ambivalent at best; its privacy and nuisance concerns about residential telemarketing are less clearly applicable to text messaging.” “And congressional silence is a poor basis for extending federal jurisdiction to new types of harm. We take seriously the silence of that political branch best positioned to assess and articulate new harms from emerging technologies.”
At bottom, the court held that the receipt of a single unsolicited text message, without more, cannot constitute a sufficient injury in fact to confer Article III standing under the TCPA: “The chirp, buzz, or blink of a cell phone receiving a single text message is more akin to walking down a busy sidewalk and having a flyer briefly waived in one’s face. Annoying, perhaps, but not a basis for invoking the jurisdiction of the federal courts. All told, we conclude that [the plaintiff’s] allegations do not state a concrete harm that meets the injury-in-fact requirement of Article III.”
The Eleventh Circuit also directly addressed the Ninth Circuit’s decision in Van Patten v. Vertical Fitness Group, LLC, 847 F.3d 1037 (9th Cir. 2017), stating that it is a “broad overgeneralization” to conclude that an isolated text message constitutes “unsolicited contact” establishing “concrete harm.” (Although not mentioned by the Eleventh Circuit, in Van Patten, the plaintiff also received multiple text messages – not just one as in Salcedo.)
The Salcedo decision will create new challenges for class certification, certainly in the Eleventh Circuit and potentially elsewhere. It will be crucial that class members be able to identify specific harms caused by the receiving a text message. This will undoubtedly be a high hurdle for any class.
Now, repeat after me: “Sticks and stones may break my bones, but in the Eleventh Circuit a single text message might not hurt me.”
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D&O insurance typically defines the term “Claim” to include criminal charges after indictment. However, the coverage available under the policy for criminal proceedings is excluded in the event of a final adjudication determining that precluded misconduct actually took place. But what happens to the coverage if there is no final adjudication but rather the criminal charges are resolved through a negotiation that results in a monetary payment by the criminal defendants? In a recent decision, the Eleventh Circuit determined that the applicable D&O insurance policy’s coverage did not extend to amounts paid in negotiated resolution of criminal charges, despite the absence of a final adjudication – not by operation of the exclusion, but because of the nature of the payments.
Sabal Insurance Group, an insurance agency, and its CEO, were criminally charged with grand theft in connection with the alleged overcharging of insurance premiums paid by certain governmental agencies. The criminal defendants ultimately settled the charges by stipulated settlement agreement in which the criminal defendants agreed to make three payments: (1) payment to the governmental agency of approximately $180,000 (“the Payment”); (2) a donation of $100,000 to a charitable organization (“the Donation”); and (3) a payment of costs of investigation to the governmental agency of $20,000 (“the Costs of Investigation”).
When Sabal received the first subpoena in connection with the premium overcharge investigation, it submitted the matter to its insurer, which accepted the subpoena as a Claim, subject to a reservation of rights. As the investigation unfolded and after the entry of the criminal information, the carrier issued updated reservations of its rights. After Sabal agreed to pay the various amounts in connection with the settlement, it sought indemnification for the payment amounts from its insurer. The insurer denied an obligation to indemnify the company for the amounts because, the insurer said, the amounts were restitutionary in nature and therefore not covered under the policy.
The insurer filed an action in federal court seeking a judicial declaration that its policy did not cover the amounts paid in the settlement. The parties filed cross-motions for summary judgment. The district court granted the insurer’s summary judgment motion, ruling that the insurer was not obligated to indemnify Sabal for the Payment and the Costs of Investigation because the amounts were restitutionary in nature, and because the Donation represented a criminal penalty. Sobel appealed the district court’s ruling to the Eleventh Circuit.
The August 26, 2019 Opinion
In an August 26, 2019 opinion marked “do not publish” and written for a unanimous three-judge panel by Judge Mark Walker, the Eleventh Circuit affirmed the district court’s holding. The appellate court agreed with the district court that the Payment and the Costs of Investigation amounts were restitutionary in nature, and that the Donation represented a criminal penalty, and therefore that coverage for all three amounts was precluded from coverage under the policy.
In reaching the conclusion that the policy provided no coverage for the Payment, the Court first agreed with the district court’s determination that as a matter of Florida law, an insurance contract precludes coverage for the restitution of ill-gotten gains. Public policy considerations under Florida law preclude coverage because “the restitution of ill-gotten gains could encourage commission of a wrongful act” and also because “excluding coverage would deter wrongdoing, while allowing coverage would only compensate the wrongdoer.”
Sabal tried to argue that coverage for the payment of ill-gotten gains is precluded only if the occurrence of wrongdoing has been determined by a final and non-appealable adjudication, as required by the policy’s conduct exclusions. The appellate court rejected this argument, agreeing with the district court that under Florida law, an exclusionary provision does not apply unless there is coverage in the first place. The appellate court said that “because the policy does not provide coverage for the restitution of ill-gotten gains, there is no need to look to the exclusionary provision.”
The appellate court then agreed with the district court that the amount of the Payment represented the payment of ill-gotten gains. In arguing against this conclusion, Sabal relied on several statements in the settlement agreement that the amounts were being paid in resolution of disputed claims and that the payments were made “without there being any admission of guilt.” The district court had rejected these arguments because, the appellate court said, the payments were clearly restitutionary in nature. The appellate court said that the Payment was made to resolve a charge of grand theft, and the amount of the payment is equal to the amount of Sabal’s “ill-gotten gains” (or at least those within the statute of limitations). The provisions in the settlement agreement in which Sabal did not admit guilt “are irrelevant, because the admission of guilt is not required for a payment to be the return of ill-gotten gains.”
The appellate court also agreed that the amount of the Donation does not represent covered loss; while the Donation itself did not represent restitution, coverage for the amount nevertheless was excluded because the policy specifies that criminal or civil fines or losses are precluded from Loss covered under the policy. The amount, the court said, was agreed to between Sabal and the state of Florida to resolve criminal charges and “accepted and ratified” by the court, and therefore the Donation is a “penalty imposed by law” for which coverage is precluded under the Policy.
Finally, the court found that coverage for the Investigative Cost portion of the settlement was also precluded because the payment of the Investigative Cost was also restitutionary in nature.
Woven through this insurance coverage opinion is an underlying notion that wrongdoers should not be able to evade the consequences of their misconduct through the protection of insurance. Whatever the theoretical merits may be of this underlying assumption as a general matter, I think there is an argument that this principle is irrelevant in the context of this insurance coverage dispute.
To be sure, the insurance agency was accused of felony misconduct, and we can all agree that that is bad. However, there was never a point in this process where it was proven or established that the agency had actually engaged in the alleged misconduct. The settlement was expressly intended to resolve a contested matter, and the State of Florida expressly agreed to a document specifying that the criminal defendants denied any admission of guilt. At no point in the criminal proceeding did the matter move beyond the presumption of innocence which in our system of justice applies to anyone accused of a crime. Moreover, as far as I can tell, there was nothing in the criminal defendants’ settlement with the State of Florida that precluded them from seeking insurance for the payment amounts.
The court’s analysis of this coverage matter only makes sense if the agency was in fact guilty of the criminal misconduct of which it was accused. Indeed, the amounts the agency supposedly improperly gained are only “ill-gotten” if the agency actually violated the law. But there was never a determination by any finder of fact that the agency in fact that realized “ill-gotten” gains. All we have are mere allegations, which the parties resolved by mutual agreement of disputed matters.
For me, because there has been no finding of fact that the agency actually committed the criminal misconduct of which it was accused, and because there has been no actual factual determination that the amounts in question were in fact “ill-gotten,” it is not appropriate for the Court to disregard the after adjudication requirement of the conduct exclusions. The effect of the Court’s logic here, by which coverage is precluded based only on unproven charges, disregards and frustrates the purposes of the actual policy language to which the parties agreed, and substitutes coverage preclusive terms and effects that are found nowhere in the policy language. And while every contract incorporates the requirements of law, Florida’s law precluding coverage for restitutionary amounts only applies to “ill-gotten gains” – which is irrelevant if there has been no determination that the amounts are in fact “ill-gotten.” All of these arguments to me apply equally to the agency’s agreement to pay the Costs of Investigation as well.
The appellate court’s conclusion that the Donation represents a “penalty” for which coverage is precluded under the policy arguably is also misplaced. The carve-out in the policy’s definition of Loss applies only to criminal or civil fines or penalties “imposed by law.” I think there is a good argument to be made that the agency’s agreement to make the Donation was a voluntarily undertaken made in order to resolve disputed allegations, and not a penalty imposed by law. Obviously the district court and the appellate court disagreed with this analysis.
The bottom line for me is that if coverage precluding principles are going to be inferred into bargained- for insurance contract, these extracontractual principles should be construed and applied very narrowly, so as not to frustrate the intended purposes of the parties’ contract. I think there is a good argument to be made here that the court has applied the extracontractual legal principles in an overly-broad way that undermines the intent and purpose of the insurance contract as reflected in the after adjudication language in the conduct exclusions.
I suspect that many readers may disagree with my analysis. I hope these readers will please provide their contrasting points of view using this site’s comment feature.
An August 29, 2019 post on the Squire Patton Boggs law firm’s Insurance and Reinsurance Disputes Blog about the Eleventh Circuit’s ruling can be found here.
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The D&O Diary completed its overseas itinerary with a final stop earlier this week in the prosperous city state of Singapore, where I participated as a speaker and as a panelist at the 2019 PLUS Singapore Symposium.
The PLUS Singapore Symposium is annual event, now in its eighth year. It has been my pleasure to participate in the event several different times. I think the event gets better every year. My thanks to the Singapore Committee for inviting me to participate in this event, especially my good friends Ronak Shah of QBE, Shasi Nair of Berkley Asia, and Arati Varma of Marsh, who have done such a good job over the years to ensure that this event is really the premier professional liability insurance event in Singapore.
It was great being back in Singapore again, to see old friends and to make new friends as well.
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Venable’s dynamic Entertainment and Media Group is pleased to launch Close-Ups, a blog aimed at providing insider commentary on legal and business issues, trends, and headlines in Hollywood and beyond. As a reader of our All About Advertising Law blog, you recognize the value of timely legal analysis and commentary on the issues surrounding your business. The team of writers and editors producing Close-Ups embraces the same innovative and creative approach to their analysis of the entertainment and media industries as they do to their counseling of major studios, agencies, talent, management, and more. Read the inaugural edition and subscribe to Close-Ups at www.closeupsblog.com.
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In Town of Flower Mound v. Eagle Ridge Operating LLC, an operator’s injunction against enforcement of a local ordinance was dissolved. EagleRidge operates gas wells in the Flower Mound. A Town ordinance prohibits work on gas wells (other than drilling) at times other than between 7 a.m. and 7 a.m. Monday through Friday and certain times on Saturday.
EagleRidge tried to avoid enforcement of the ordinance by:
All of the requests were denied by the Town and its agencies. EagleRidge sued and the trial court enjoined the Town from enforcing ordinances that have the intent or effect of restricting hours in which EagleRidge and its contractors could haul produced water.
Upon further review …
The court of appeals dissolved the inunction, holding the trial court had no subject matter jurisdiction over the dispute because the ordinance is penal in nature. (A violation is considered “unlawful” and is punishable by fine.)
The wrong the ordinance protects against involves the violation of public rights and duties that affect the whole community, considered as a community (rather than infringements of private civil rights belonging to individuals, considered as individuals). In support, the court cited the stated premise of the ordinance: “ … natural gas drilling and production operations involve or otherwise impact the town’s environment, infrastructure[,] and related public health, welfare[,] and safety matters[.]”
The reversal was also for reasons that trial lawyers are used to seeing:
Your musical interlude
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The D&O Diary’s overseas assignment continued this week with a stop in Mumbai, India’s financial capital. I was in Mumbai to participate in the annual Bima Gyaan Symposium, an educational and networking event for the professional liability insurance industry in India. As reflected in the pictures below, the event was once again well-attended and was a great success.
The name Bima Gyaan means “insurance knowledge” in Sanskrit. The annual Bima Gyaan event, which is co-sponsored by the Professional Liability Underwriting Society (PLUS), is the premier professional liability insurance event in India. It was pleasure and honor to be able to speak on the topic of D&O Claims Trends and Developments. I always enjoy speaking to and meeting with this group. The audience is young, attentive, and interested. I was pleased to find that so many of the audience members read The D&O Diary. I would like to thank the event committee for inviting me to participate in this event again this year, particularly Suresh B of Trans Asia Advisors and Uttara Vaid of Uttara Vaid Advisory.
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In the following guest post, Jeremy Salzman and Kylie Tomas of Sompo International and Ommid Farashahi and Jonathan Cipriani of BatesCarey LLP discuss a recent series of Delaware court decisions in which the courts applied Delaware law in addressing insurance coverage disputes. In their article, the authors question Delaware law appropriately should have been the law applied in those cases. I would like to thank the authors for allowing me to publish their article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this blog’s readers. Please contact me directly if you would like to submit a guest post. Here is the authors’ article.
It is no secret that Delaware courts exert significant influence on the American corporate law landscape. With more large companies incorporated in Delaware than any other state, Delaware boasts a bench that is extremely well-versed in corporate law issues.
A disturbing trend has developed recently, however, with Delaware courts expanding their influence even further, into the area of insurance law. In a spate of recent decisions, Delaware courts have applied Delaware law to insurance coverage disputes, essentially by default in the absence of a choice of law provision, where the policyholder is incorporated in Delaware. Delaware courts have given little to no regard to, for example, the state where the policy was issued, the state where the policyholder is headquartered, or state amendatory endorsements, attached to the policy, reflecting the intent of the parties to be subject to the law of certain state (other than Delaware).
This unfortunate trend has significant consequences for insurance carriers issuing policies to Delaware-incorporated insureds. These include the increase in the number of coverage actions filed by policyholders against insurers in Delaware, as well as the application of Delaware insurance law, which is often less favorable to insurers than the law of other jurisdictions.
This article discusses how this trend has developed, why this matters to insurers, and what steps insurers can take in response.
The Mills Case
Back in 2010, a Delaware trial court applied Delaware law to an insurance coverage dispute, despite the fact that the insured was headquartered in Virginia and the policy was issued in Virginia. Mills Ltd. P’ship v. Liberty Mut. Ins. Co., 2010 WL 8250837 (Del. Super. Ct. Nov. 5, 2010). Mills involved a coverage dispute, under a D&O policy, regarding exhaustion of underlying insurance. The insured was incorporated in Delaware, but headquartered in Virginia, where the policy was issued. The Mills court opined that, in cases where “the insured risk” is the business conduct of directors and officers located in states across the country or even throughout the world, Delaware will look to factors including the place of contracting, the place of negotiation of the contract, the place of performance, the location of the subject matter of the contract, and the domicile, residence, nationality, place of incorporation, and place of business of the parties. Id. at *5.
While purporting to look at all of these factors, the court stated that, where the underlying litigation involves the directors’ and officers’ “honesty and fidelity to the corporation,” the state of incorporation has a more significant relationship to the policy than the place where the insured has its physical headquarters. In the court’s words: “[The insured’s] directors and officers caused a Delaware corporation to defraud its investors, which made the corporation liable and triggered the corporation’s D&O policy. In a case like this, what difference does [the] headquarters’ location make to the company or the people involved?” Id. at *6. Accordingly, the court applied Delaware law, holding that Delaware employs the “functional exhaustion” rule, which was fatal to the insurer’s exhaustion-based coverage defense.
The Recent Trend
For almost a decade, the Mills decision was considered by many to be an aberration, with no other court following its choice of law analysis – until recently. In March of 2018, another Delaware trial court applied Mills, holding that Delaware law applied, even though the insured was headquartered in California, the policy was issued there, and the policy included California state amendatory endorsements. Arch Ins. Co. v. Murdock, 2018 WL 1129110 (Del. Super. Ct. Mar. 1, 2018). Nevertheless, relying upon Mills, the court applied Delaware law, reasoning that the conduct of the insured’s directors and officers was centrally implicated; that the insured risk involved their “honesty and fidelity” to the corporation; that the individual defendants held management positions pursuant to Delaware law; that the situs of the company’s shares was Delaware; and that prior court rulings had involved Delaware law. The court held that Delaware law, unlike California, did not preclude an insurance indemnity payment for an insured’s fraud, and required the insurers to demonstrate prejudice from the insureds’ violation of the consent provision.
Thereafter, in IDT Corp. v. U.S. Specialty Ins. Co., 2019 WL 413692 (Del. Super. Ct. Jan. 31, 2019), the insured was a Delaware corporation with its principal place of business in New Jersey. The court concluded that Delaware law applied because the insured was incorporated in Delaware, the policies covered D&O liabilities involving the insureds’ “honesty and fidelity” to the corporation, and the merits of the underlying litigation were governed by Delaware law.
In Verizon Commc’ns, Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 2019 WL 2517418 (Del. Super. Ct. Apr. 26, 2019), the same judge who decided the Murdock case held that Delaware law applied to a D&O policy and, thus (for that reason among others), the coverage action should proceed in Delaware, not New York, even though the insurers filed a dueling action in New York.
More recently, in Pfizer, Inc. v Arch Ins. Co., 2019 WL 3306043 (Del. Super. Ct. July 23, 2019), even though the insured’s principal place of business was in New York, the policy was issued in New York, the policy contained New York amendatory endorsements, and the underlying lawsuit was filed and pending in New York, the Delaware court applied Delaware law, relying on Mills and Murdock.
If this trend continues, the insurance industry can expect Delaware trial courts to apply Delaware law to insurance coverage disputes, essentially by default in the absence of a choice of law provision, where the policyholder is incorporated in Delaware, regardless of where the policy was issued or where the policyholder is headquartered.
Why This Matters to Insurers
While anecdotal, we have seen a significant increase in the number of coverage actions filed by policyholders in Delaware in an effort to avoid litigating in a jurisdiction more likely to apply the law of state where the policy was issued. Not only has the number of such actions increased, but the timing of the filing of these actions has changed as well. In order to “plant the flag” in Delaware, policyholders have been filing coverage litigation more quickly than before, resulting in less pre-litigation dialogue or negotiation between the parties.
This trend is also important to insurers because Delaware insurance law can be particularly unfriendly to insurers. For example, in the Pfizer case discussed above, the Delaware court was asked to decide a “related claims” issue. Finding that Delaware law, not New York law, applied, the court imposed Delaware’s very narrow “relatedness” test and held that two claims were not related because they were not “fundamentally identical.” See Pfizer, 2019 WL 3306043, at *10. Importantly, if the dispute had been decided under New York law, the insurers could have relied on New York’s broader “sufficient factual nexus” test.
Another example is that, unlike courts in other jurisdictions, Delaware courts will not sustain a coverage defense based on an insurer’s lack of consent to settle an underlying case, unless the insurer can show prejudice. See Murdock, 2018 WL 1129110, at *13.
Delaware is also less favorable to insurers with respect to coverage for disgorgement. Compare Gallup, Inc. v. Greenwich Ins. Co., 2015 WL 1201518, (Del. Super. Ct. Feb. 25, 2015) (where a claim for disgorgement is settled without a final adjudication, there is coverage for the settlement, even if disgorgement is uninsurable), with Phila. Indem. Ins. Co. v. Sabal Ins. Grp., Inc., — F. App’x —, 2019 WL 4014100 (11th Cir. Aug. 26, 2019) (rejecting case law holding similarly to Gallup and finding no coverage for settlement of disgorgement claim based on traditional “no Loss” analysis).
How Insurers Can Respond
How can insurers respond to this trend? As to policies already in the marketplace, of course, the industry can continue to seek a good ruling from a different Delaware trial court judge on this issue, presumably based upon a particularly good set of facts. In addition, insurers can seek appellate relief from the Delaware Supreme Court (there is no immediate appellate court in Delaware). However, a challenge to a court’s early decision on choice of law may not be possible until the underlying case is tried or otherwise disposed of by motion, and cases rarely go that far down stream. In addition, it is critical that, if the industry does seek relief from the Delaware Supreme Court, it must evaluate carefully the best “test case” to send up, as a “close call” case could yield a decision from Delaware’s highest court unfriendly to the industry. In the meantime, absent a decision from the Delaware Supreme court, while a “race to the courthouse” is never the preferred option, insurers should consider filing first in the “right” jurisdiction when faced with a coverage dispute, anticipating that the policyholder will likely file in Delaware.
As to policies yet to be issued, there is one clear option – to include a choice of law provision in the policy identifying the law of a state other than Delaware. Insurers may choose to apply the law of the state where the insured is headquartered. Many insurers and insureds probably assume that is the law that will govern the policy anyway, so this may simply reinforce pre-existing expectations of the parties. Of course, it will behoove insurers to be aware of any unique risks or concerns presented by a given jurisdiction and to consider the choice of law provision in light of all relevant factors. Another option is to include a New York choice of law provision, which has been traditionally included by certain markets, and therefore should not be particularly controversial with policyholders or their brokers. Even this option, however, may be subject to challenge, as illustrated by a recent decision by the California Supreme Court. In Pitzer College v. Indian Harbor Insurance Company, 2019 WL 4065521 (Cal. Aug. 29, 2019), the Court held that, even though a policy contained a New York choice of law provision, the court applied California law to certain notice issues, because the issues concerned a “fundamental public policy” of California. Yet another potential option could involve policy language outlining binding arbitration in connection with disputes arising from the application of a policy’s choice of law provision.
While it is unfortunate that insurers must now expect Delaware courts to apply Delaware law where the policyholder is incorporated in Delaware, absent a choice of law provision or other policy built-in procedure, this appears to be the “new normal,” at least for now. But, as discussed above, there are steps that insurers can take, both with respect to those policies already in the marketplace and future policies.
This article is intended for informational purposes, only. It does not constitute legal advice. Nor is it a substitute for legal advice.
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via Tumblr Guest Post: No Choice of Law in Delaware Coverage Disputes?
The D&O Diary is on assignment overseas this week with a lengthy itinerary including multiple stops. The first stop on my schedule was in Israel, where I had business meetings in Tel Aviv. My timetable while I was in Israel also allowed an opportunity for a first-time ever visit to Jerusalem. As reflected in the pictures below, the Jerusalem stopover was a truly extraordinary experience.
The primary purpose for my visit to Israel was to participate as the keynote speaker at an event organized by Howden Israel, in collaboration with the Pearl Cohen law firm. The event was well-organized and very well-attended. The audience was lively and attentive – and asked a lot of questions. It was a pleasure to meet so many industry professionals and attorneys who read The D&O Diary. It was also interesting to learn about how much is going on in Israel both as far as economic activity and business development, and in terms of directors’ and officers’ liability and insurance issues, as well. I would like to thank Izik Malik of Howden Israel and Piers Davies and Lianne Gras of RKH Specialty for inviting me to be a part of this terrific event, and for being such excellent hosts while I was in Tel Aviv.
Before my visit to Tel Aviv, I spent the weekend in Jerusalem. I have to admit that I had very high expectations for my Jerusalem visit. Seeing Jerusalem is something that I have basically wanted to do my entire life. Though my expectations were high, the visit to the Holy City far exceeded my expectations. Jerusalem is an amazing place.
In some really important ways, the weekend is absolutely the wrong time to visit Jerusalem. On Fridays and Saturdays, the Jewish and Muslim sites are closed. Of greatest significance, Temple Mount is closed to non-Muslims on Fridays and Saturdays. I was not able to visit Temple Mount until Sunday morning, the last day of my stay in Jerusalem. The hours in which non-Muslims may visit Temple Mount are short, from 8:30 am to 11:30 am. The guide books warn that due to security controls the lines to enter can be very long, so I got there early to be in line when it opened at 8:30. As it turned out, the gates had opened at 7:30, so there was no line at all when I arrived. I did face a one question interrogation (in English): “Where you from?” When I said I was from the United States, the security guard waived me through impatiently. These are not the Droids that you are looking for.
After the wonder and amazement of Jerusalem, Tel Aviv required a little mental adjustment. Tel Aviv is a prosperous, crowded, busy place traffic-clogged streets — and a great beach and great night life. Fortunately, I had time while I was in Tel Aviv to enjoy the beach.
A final note. For anyone planning a visit to Jerusalem (or for anyone who wishes to visit but who can’t travel there now), I strongly recommend Simon Sebag Montefieore’s excellent book “Jerusalem: The Biography.” The book covers the city’s complicated and multi-layered history thoroughly yet entertainingly. Montefiore reviews the city’s history from the time of King David through the Six-Days War. Reading this book substantially enhanced my enjoyment of visiting Jerusalem. It was also extraordinarily helpful in explaining the current situation in the city, as well.
via Tumblr Jerusalem and Tel Aviv
As discussed in prior posts, after the Delaware courts evinced their distaste for the type of disclosure-only settlements that had until then typically resolved merger objection lawsuits, the plaintiffs’ lawyers changed their game. They began filing their merger objection lawsuits in federal court rather than in state court, and then rather than settling the cases, agreed to dismiss their cases in exchange for supplemental proxy disclosures, after which the plaintiffs would seek to recover a so-called “mootness fee.” At least one federal judge recently questioned this “racket,” but the question remained whether more courts would take steps to scrutinize this process and discourage what has become nothing more than the plaintiffs’ lawyers’ extraction of a “go away” payment.
In a positive sign suggesting that court may indeed become more involved in policing this process, a District of Delaware judge recently rejected merger objection lawsuit plaintiffs’ mootness fee petition on the ground that the plaintiffs failed to carry their burden of showing that the supplemental disclosures produced a substantial benefit for the acquired company’s shareholders.
The Delaware litigation arose out of the $5.4 billion acquisition of DST Systems, Inc. by SS&C Technologies. Shortly after DST filed a proxy statement describing the transaction, shareholders filed three lawsuits alleging that the preliminary proxy statement omitted material information in violation of Sections 14(a) and 20(a) of the ’34 Act. DST voluntarily issued a supplemental disclosure to moot the pending lawsuits. The plaintiffs’ agreed the supplemental disclosures mooted their lawsuits, and sought recovery of their attorneys’ fees.
In response to the plaintiffs’ attorneys’ fees petition, the court requested supplemental briefing. The court’s supplemental briefing request reflects a palpable skepticism about the fee request. For example, in the court’s question number 2, the court asks “The Parties request fees for three virtually identical lawsuits. Why should three plaintiffs receive attorneys’ fees for the same supplemental disclosure?” The court’s question 4 notes “Dennis Pratt, a plaintiff in a now-settled Missouri suit, has not entered an appearance in either case, but is requesting that I award him attorneys’ fees. What legal authority supports the propriety of Mr. Pratt’s request?”
As far as I can tell from the record, the defendants opposed the plaintiffs’ fee petition, which is somewhat unusual in these kinds of cases. To the extent the defendants did indeed oppose the petition, I cannot tell why. However, the defendants’ response to the court’s request for supplemental briefing – particularly with respect to the prevalence of this type of merger objection litigation and the near uniformity of outcomes for these kinds of cases (that is, supplemental disclosures and a request for mootness fees) – makes for interesting reading.
The August 23, 2019 Opinion
In an August 23, 2019 opinion (here), District of Delaware Judge Richard G. Andrews denied the plaintiffs’ fee petition, finding that the plaintiffs had failed to carry their burden in establishing that the supplemental disclosures produced a “substantial benefit “on DST shareholders. The court said a review of the supplemental disclosures “reveals that Plaintiffs have failed to carry their burden on materiality of the information.” The Plaintiffs, the court said, “have not established that they provided the stockholders with a substantial benefit so as to warrant an award of attorneys’ fees.”
In making this determination, the Court noted that the plaintiffs did not develop a factual record or proffer expert opinion in support of their contention that the supplemental disclosures had conferred a substantial benefit on DST’s shareholders. Essentially, the court noted, the plaintiffs argued that the information was so plainly material that its disclosure was a substantial benefit as a matter of law – about which the Court said, “I do not find Plaintiffs’ position persuasive.”
To the contrary, the court said, “it is far from clear, as a factual matter in this case, that the information disclosed by Defendants was material.” The various arguments, opinions from other cases, and law review articles on which the plaintiffs relied “do not carry the weight Plaintiffs put on them.”
The court concluded that “absent evidence that the information was material, there is no basis in the record to find that Plaintiffs conferred any benefit on DST stockholders.” Simply put, the court said, “there is no basis in the record to find that Plaintiffs conferred any benefit on DST stockholders.” Thus, the court said, “I will deny Plaintiffs’ motion for attorneys’ fees.”
The most positive thing about this decision is the court’s willingness to become actively involved in assessing the merits of the fee petition. The truth is that what Judge Andrews said about the supplemental disclosures in this case could be said in virtually every single one of these merger objection lawsuit mootness fee cases. The point of this racket is not to produce an actual benefit for shareholders. The point is to provide a pretext for the plaintiffs’ lawyers’ to extract a fee, which the defendants pay just to make the plaintiffs’ lawyers go away.
It is particularly significant that the court applying the scrutiny to this fee request was the District of Delaware. Although plaintiffs’ lawyers have been filing their merger objection lawsuits in a very wide range of federal district court, there have been a plethora of these lawsuits filed in the District of Delaware. For example, of the 101 federal court merger objection lawsuits filed year-to-date this year, 65 were filed in the District of Delaware. If the outcome of this fee petition can be interpreted to signal that the judges in the District of Delaware are going to more closely scrutinize petitions for mootness fees more closely, the attractiveness to the plaintiffs’ lawyers for filing these cases in the District of Delaware could be significantly undermined.
To be sure, Judge Andrews only said that these plaintiffs in this case did not carry their burden of showing a substantial benefit to shareholders. There is nothing about the opinion to suggest that another plaintiff in another case might not be able to carry its burden – or even that these plaintiffs might not have been able to meet their burden if they had done a better job marshalling the evidence to support their petition. The court said only that the plaintiffs had failed to come forward with evidence to support their argument that their lawsuit provided a substantial benefit to shareholders.
Moreover, even if it is the case that the court’s ruling on the plaintiffs’ fee petition here can be interpreted to suggest greater fee petition scrutiny by the judges in the District of Delaware, the plaintiffs’ lawyers can always try to file their lawsuits in another federal district court, where mootness fee petitions might not face the same level of scrutiny.
That said, it certainly is a welcome development to see a court take a close look at a mootness fee case resolution. We can only hope that more judges in more of these cases become similarly involved; the fact is that these kinds of lawsuits are an embarrassment to our entire legal system. If enough courts scrutinize enough of these suits, pretty soon the plaintiffs’ lawyers will have to find another way to make a living. To paraphrase Hamlet, it is a consummation devoutly to be hoped for.
Special thanks to a loyal reader for providing me with a copy of Judge Andrews’s opinion.
The post Delaware Federal Court Rejects Merger Objection Plaintiffs’ Mootness Fee Request appeared first on The D&O Diary.
via Tumblr Delaware Federal Court Rejects Merger Objection Plaintiffs’ Mootness Fee Request
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