Sanctions for failing to investigate insurance under Federal Rule 26

In two recent cases, lawyers have been sanctioned for failing to understand their client’s insurance program. These cases (along with others from the past) illustrate that courts are increasingly placing a burden on defense lawyers to have a basic understanding of insurance and to thoroughly discuss insurance matters with their clients.

North Carolina attorney sanctioned for failing to disclose umbrella policy

Last December, the United States District Court for the Western District of North Carolina sanctioned an insurance defense lawyer with a $1,000 sanction because the Court found that she failed to properly discuss and review the applicable insurance her client had for a claim. Further inquiry would have revealed a $10 million umbrella policy above the first $1 million layer of commercial general liability insurance. Palacino v. Beech Mountain Resort, Inc., 2015 WL 8731779 (W.D.N.C., Dec. 11, 2015).

Under Federal Rule of Civil Procedure 26(a)(1)(A)(iv), a defendant must disclose, relatively early in a case, “any insurance agreement under which an insurance business may be liable to satisfy all or part of a possible judgment in the action or to indemnify or reimburse for payments made to satisfy the judgment.” In this case, the umbrella policy was only disclosed after mediation and after discovery closed. The Court concluded that this was a violation of Rule 26, as “Defendant was legally obligated to disclose both [insurance] policies in its Initial Disclosures, and its failure to do so violated its obligations under the Federal Rules of Civil Procedure and the Court’s Pretrial Order.”

By only disclosing the first $1 million in coverage under the CGL policy – presumably the policy which the attorney was retained under – the attorney neglected to investigate the full range of available insurance and to disclose the $10 million umbrella. The attorney submitted an affidavit stating that, in responding to Rule 26, the Risk Manager for the defendant was asked to provide all applicable insurance policies. However, the Court ruled that this was not enough. It noted that the attorney's affidavit in opposition to sanctions did not state that the attorney "independently verified the completeness of the information provided" or that "additional steps [were taken] to ensure that the information" provided in the Initial Disclosures was complete "or that a reasonably inquiry was made prior to providing the Initial Disclosures." The Court goes on to state that the attorney should have been able to "represent to the Court that she undertook [an] independent inquiry to verify whether the information provided by [the Risk Manager] was complete prior to signing the" Initial Disclosures. However, the Court gave no guidance as to how a retained defense attorney is to show that “a reasonable inquiry [into insurance policies] was made prior to providing the Initial Disclosures” other than asking the Risk Manager – presumably the most knowledgeable employee of the defendant – to provide all insurance policies. Does this require asking other employees of the client? Reaching out to the client's insurance broker? Physically inspecting the client's files?

In addition to the $1,000 sanction against the attorney, the client was also fined $500 for its failure to uncover and disclose the umbrella policy.

Tenth Circuit affirms sanction for failing to disclose D&O policy

In Sun River Energy, Inc. v. Nelson, 800 F.3d 1219 (10th Cir. 2015), decided last September, the Tenth Circuit affirmed an award of sanctions against counsel for failing to disclose the company’s directors and officers (D&O) insurance policy in its initial disclosures.

In that case, the Plaintiff had a "Directors and Officers Liability Insurance Policy including Employment Practices and Securities Claims Coverage" which arguably provided coverage for certain counterclaims which the Defendant may have made. However, by the time the policy was disclosed, any potential coverage under that “claims made” policy had lapsed.

The federal magistrate judge, in issuing the underlying sanction, wrote that counsel never “took a serious look at whether there was applicable insurance” and “exhibited deliberate indifference to the obligation of providing relevant insurance information under Rule 26.”

Importantly to defense counsel, the Tenth Circuit flatly rejected the attorney’s excuse that “counsel need not bother to review the actual terms of an insurance policy . . . before denying the existence of the potential coverage, so long as he believes the existence of coverage would be very unlikely or unusual.” Instead, defense counsel is obligated to review all applicable policies and then provide the information required by Rule 26 when completing Initial Disclosures. Implicit in the Tenth Circuit’s ruling is that the lawyer must have a basic understanding of insurance law and whether certain policies may provide coverage for the claims at issue.

Finally, no discussion of defense counsel’s potential insurance obligations is complete without reference to Shaya B. Pacific, LLC v. Wilson, Elser, Moskowitz, Edelman & Dicker, 827 N.Y.S.2d, 231 (N.Y. Sup. App. Div. 2006). In that New York case, the court held that an attorney could be liable for negligence/malpractice for failing to investigate his client’s insurance coverage for a claim or failing to notify the insurer of a claim. However, the determination of negligence would also turn on “the scope of the agreed representation.” Clarifying the scope of representation - by excluding any obligation to consult on insurance coverage - is thus important to attorneys who do not feel comfortable opining on insurance matters.

Tightening up regulations over commercial vehicle insurance

On March 1, 2016, WRAL Investigates reported that North Carolina Insurance Commissioner Wayne Goodwin wants state lawmakers to tighten up regulations over commercial vehicle insurance, stating that some out-of-state trucking companies are claiming in-state residency to obtain lower insurance rates.

It is no secret that North Carolina has some of the lowest vehicle insurance rates in the country. These insurance policies, however, are available only to residents and businesses that reside in the state. According to WRAL, ten years ago, drivers from New York and New Jersey were registering their cars in North Carolina in order to get cheaper car insurance. But, the General Assembly changed the law to stop this from happening.

Today, the same issue is occurring in the $670 million-a-year commercial vehicle insurance market. Reportedly, North Carolina Insurance Commissioner Wayne Goodwin is seeking to have a similar statutory enactment passed. In recent years, the North Carolina Reinsurance Facility raised its commercial rates because of significant claim losses. Goodwin attributes this increase in commercial rates to out-of-state trucking companies claiming in-state residency to obtain lower insurance rates. Goodwin has been quoted as saying: "They have accidents in other states and the like. It impacts insurance rates for the legitimate businesses that are here, and it's becoming a growing problem."

WRAL Investigates confirmed North Carolina freight insurance coverage for Senn Freight Lines in Newberry, S.C. A spokesman for Senn stated that the company has no North Carolina operations, although an internal insurance memo indicated that Senn claims one truck registered and one driver licensed in the state. According to the Secretary of State's Office, another trucking company, Fast Transport, Inc., is listed as a North Carolina registered corporation. However, the address listed for Fast Transport is in a remote residential neighborhood in Wake Forest, and a spokesman for Fast Transport stated that the Wake Forest house is the trucker's accounting headquarters. According to WRAL's investigation, Fast Transport claims dozens of trucks in Florida, Georgia, and Texas but only one truck in North Carolina.

The Insurance Commissioner's position seems to be that only North Carolina companies should be able to take advantage of the state's lower insurance rates. He wants "to protect and help the legitimate companies that are doing business in North Carolina from being taken advantage of by businesses...that are misleading the state and misleading insurance companies as to their presence in the state.

As a result, Goodwin's office is drafting legislation to present to the General Assembly when lawmakers reconvene in April that would better differentiate between North Carolina companies and posers exploiting the law to get cheaper rates.

No Coverage, but Liability for Unfair or Deceptive Practices: The Question of Damages in North Carolina and a Current Case to Watch

There is a current case pending in the Western District of North Carolina that will likely add to North Carolina’s divergent case law regarding the measure of damages in an unfair and deceptive practices claims against insurers.

Background

Unlike other states, North Carolina recognizes liability for unfair and deceptive practices or bad faith even absent insurance coverage. “Thus, even if an insurance company rightly denies an insured's claim, and therefore does not breach its contract, as here, the insurance company nevertheless must employ good business practices which are neither unfair nor deceptive.” Nelson v. Hartford Underwriters Ins. Co., 177 N.C. App. 595, 609, 630 S.E.2d 221 (2006).

So, in cases where there is no insurance coverage, if an insurer is liable for bad faith or unfair and deceptive practices, one of the most important questions is: What are the Damages that get Trebled? On one hand, there is case law that supports that the full contract damages should be trebled. Cullen v. Valley Forge Life Ins. Co., 161 N.C. App. 570, 578-79, 589 S.E.2d 423, 430, (2003). On the other hand, there is case law that supports that only the damages that were proximately caused by the actual bad faith or unfair and deceptive trade practice. Gray v. North Carolina Ins. Underwriting Ass’n., 352 N.C. 61, 75, 529 S.E.2d 676, 685.

Current Case

For the purposes of the Motion to Dismiss, the Court assumed the facts in Plaintiff’s Complaint as true. Since Defendant has not yet answered, our discussion will also assume the veracity of Plaintiff’s facts in the Complaint.

In Biltmore Avenue Condominium Association Inc v. Hannover American Insurance Company, 1:15 CV 43 (W.D.N.C. Feb. 17, 2016), the Plaintiff was an owner of a medical office building who purchased commercial property insurance from Defendant. The policy was for $2,000,000.00, but there was a broadening endorsement that provided $500,000.00 for various potential losses. A fire occurred in the building on July 28, 2011. Plaintiff requested coverage for $2,500,000. After a series of communications, Defendant ultimately paid $2,000,000 in coverage, but denied the $500,000 under the broadening endorsement. Plaintiff wanted the additional $500,000 for reimbursement on the newly installed/upgraded sprinkler system.

Plaintiff filed a claim for breach of contract and violation of North Carolina’s Unfair and Deceptive Practices Act. For the breach of contract claim, the Court dismissed the claim pursuant to the three year statute of limitations. Because the statute of limitation for violation of North Carolina’s Unfair and Deceptive Practices Statute was four years, it was still a timely claim.

Defendant argued that because the alleged damage for the Unfair and Deceptive Practice ($500,000 endorsement value) was the same alleged for the Breach of Contract, there was actually no damages to Plaintiff for violation of N.C. Gen. Stat. § 75-1.1. Defendant argued that there must be independent damages, separate and apart from a breach of contract. Therefore, Plaintiff’s Unfair and Deceptive Trade Practice claim should be dismissed for failing to show a required element-- injury.

Resolution 

The District Court, in adopting the Magistrate’s Recommendation, dismissed the Breach of Contract claim and found that Plaintiff pled a claim for violation of North Carolina’s Unfair and Deceptive Practices Statute.

In reviewing the argument the Court emphasized that eventually, it or a factfinder will have to decide on the true measure of damages in this case. “If Plaintiff is able to prove such a claim [violation of N.C. Gen. Stat. § 75-1.1], its damages may be the same as what its contract damages would have been; and they may be different. But that inquiry is not before the Court on the present motion pursuant to Rule 12(b)(6).“ Id. 1:15 CV 43 (W.D.N.C. Feb. 2, 2016).

Defendant filed a Motion for Reconsideration, and the Court maintained its decision. “The Plaintiff’s Complaint states a claim for unfair and deceptive trade practices. If Plaintiff is able to prove such a claim, its damages may be the same as what its contract damages would have been; and they may be different. But, as stated in its prior Order, that inquiry is not before the Court on the present motion pursuant to Rule 12(b)(6). Accordingly, the Court will deny the Defendant’s motion for reconsideration and will grant Defendant’s motion for additional time to file its Answer.” Id. 1:15 CV 43 (W.D.N.C. Feb. 17, 2016).

Issues to Monitor

The District Court Judge correctly noted the current state of North Carolina’s law. In this situation, some cases allow for full contractual damages to be used and some cases recognize damages distinct from breach of contract damages. In this case, the Court twice has alluded that this inquiry will be one that will eventually be presented to the Court or fact finder.

Hopefully, this case will provide some guidance for future cases. Particularly, as it seems that the Defendant may have a viable “no causation” defense. It has suggested that Plaintiff was required to replace and upgrade the sprinkler system due to regulations and not due to any statement by Defendant.

It will be interesting if the Court provides some guidepost or insight on how to approach this issue in the future. Potential considerations could be: was the violation in the procurement of the policy as a whole? Was the violation in the adjustment after the claim occurred? Did the violation only result in a delayed award? In those cases, would interest be an appropriate measure?

Marijuana inventory covered under commercial insurance policy (D. Colo)

As the legal markets for marijuana – medicinal and recreational grow – so do the commercial insurance implications. The United States District Court for Colorado just issued an insurance coverage opinion in a case where a marijuana company sued its insurer. Green Earth Wellness Center, LLC v. Atain Speciality Insurance Company, No. 13-CV-03452-MSK, 2016 WL 632357 (D. Colo. Feb. 17, 2016). The case may have national significance going forward because Judge Kruegar, in a 27 page opinion, ruled that the inventory itself, i.e., the marijuana, was insurable under the a "Commercial Property and General Liability Insurance Policy." The ruling contains her opinions on a number of exclusions and whether they apply to commercial marijuana production.

The Plaintiff-Policyholder, Green Earth, was in the business of commercial marijuana cultivation, which it sold through its own medical marijuana dispensary. According to the opinion, smoke and ash from a nearby forest fire entered the ventilation system of Green Earth, intruding into the growing operation, and causing damage to Green Earth’s plants and inventory.

Predictably, the Insurer argued that Green Earth was not entitled to coverage because the policy included language that excluded coverage for “contraband” and “property in the course of illegal . . . trade.” More broadly, the Insurer argued that general public policy prevented coverage for marijuana companies.

The Court characterized Green Earth as having two main types of claims under the policy: a claim for $200,000 for plants currently growing, and a claim for $40,000 of marijuana which was already harvested and being prepared for sale.

Regarding the $200,000 in standing or growing plants, the Insurer argued that the exclusion for “growing crops” applied (and, indeed, the insurance quote provided to Green Earth plainly stated “Coverage does not extend to growing or standing plants.”). This exclusion is straightforward enough and was applied by the Court. “Growing crops” includes “any body of plants tended for their agricultural yield, at least until they are harvested.” Simply put, the policy is not crop insurance, even if your crop is marijuana.

The claim for $40,000 in inventory was more complex. This case, as much as others, highlights that the law of the forum is incredibly important to insurance coverage disputes. As a threshold matter, the Court applied Colorado state law, and this being a contract, only applied Colorado state law. Then, applying common insurance law maxims, the Court found that the policy failed to define “contraband” and, in light of Green Earth’s legal business in the Colorado medical marijuana trade, that the “contraband” exclusion was ambiguous. The Court went on to state that the “contraband” exclusion is ambiguous in light of the conflict “between the federal government’s de jure and de facto public policies regarding state-regulated medical marijuana.” Further, in Green Earth’s favor, the Insurer knew about Green Earth’s business in the marijuana industry prior to issuing the policy but never voiced any exception to insuring plants, marijuana-in-process, or the finished inventory.

The Insurer, in a last-ditch effort, then argued that in light of federal law, its own insurance policy was an illegal contract. The Court ruled that because the Insurer entered into the contract knowing full-well the scope of Green Earth’s business, it was obligated to either (1) comply with the contract or (2) pay damages for having breached it. This argument by the Insurer seems misguided: by intentionally arguing that an Insurer is in the business of marketing and selling insurance contracts that it believes are illegal under federal law, it essentially admits to collecting unearned premium for selling “illusory coverage” or committing other unfair or deceptive trade practices which are often prohibited by state statute and subject to double or treble damages.

There are other minor issues in the opinion as well. Green Earth, having survived summary judgment, will now have to prove its breach of contract, bad faith, and delayed payment claims at trial.

This ruling is important for a number of reasons. First, for the Court applied conventional insurance law to marijuana and cannabis growing. Second, it highlights the importance of choice of law, conflicts of law, and venue. In the case of marijuana-related businesses, and in the face of this opinion, the conflicts of law issues can be outcome-dispositive in future insurance coverage disputes. If the Court would have applied another state’s law, the Court may not have found the term contraband ambiguous, and the marijuana grower may have lost. Third, commercial marijuana growers need to investigate obtaining crop insurance if they wish to insure standing and growing plants.