Mini-MDL approved to consolidate business interruption cases against one regional insurer

 

Last week, the U.S. Judicial Panel on Multidistrict Litigation agreed to at least one mini-MDL, consolidating the business interruption lawsuits filed against Society Insurance Co.  At the same time, it decided against consolidation of cases against several other insurers, saying it would be inefficient.

In August the MDL panel ruled against centralizing all COVID-19 business interruption lawsuits because of differences between policies and unique facts of certain policyholders.  However, the panel requested additional briefing on mini-MDLs against five insurers. Those five (Lloyds, Cincinnati, Hartford, Society Insurance, and Travelers) insurers accounted for approximately 275 cases (approximately 1/3 of cases filed). 

In approving the mini-MDL against Society Insurance Company, the MDL court stated consolidation “will serve the convenience of the parties and witnesses and further the just and efficient conduct of this litigation.”  Unlike the other insurance carrier defendants, the panel noted that Society is a regional insurer only operating in six states (Minnesota, Iowa, Illinois, Indiana, Wisconsin, and Tennessee).  These cases were transferred to the U.S. District Court for the North District of Illinois, in Chicago.

In a series of separate opinions, the MDL ruled against consolidating the cases against the other insurers involved.  Generally speaking, the insurance carriers argued that local courts were already familiar with state law (which governs most substantive insurance law issues), that various states and municipalities issued unique and differing civil authority issues, that a variety of policy forms were at issue, and that any question of damages would require individualized, fact-specific attention. 

Incentive fee awards for class plaintiffs struck down by 11th Circuit

 

Last week the Eleventh Circuit shocked the legal world by ruling that incentive payments to named representatives in class actions are improper, striking a $6,000 award to the plaintiff in a Telephone Consumer Protection Act class action . Johnson v. NPAS Solutions, LLC, No. 18-12344, “Slip Op.” (11th Cir. 2020).  

Incentive awards are a special payment to the named plaintiffs in class actions.  Courts began awarding these in the 1980s, and they are commonplace today.  Civil rights and consumer protection class action settlements include incentive awards to the named plaintiffs approximately 90% of the time.  While these awards are typically small compared to the total settlement or judgment amounts – they often range from $1,500 to $20,000 depending on how involved the named plaintiffs were in the case – the incentive award is usually drawn from the common fund or otherwise paid by the defendant as an awardable cost. 

In Johnson, the defendant (a medical debt collector) and the class had agreed to settle the case for $1.432 million (which included a $6,000 payment to the named plaintiff).  Only one person opted out of the class and objected.  Relying on two cases from the 1880s, the panel held “that Supreme Court precedent prohibits incentive awards like the one” awarded to the plaintiff (and the type customary in virtually all class actions). Id. at 18. Trustees v. Greenough, 105 U.S. 527 (1882), and Central Railroad & Banking Co. v. Pettus, 113 U.S. 116 (1885).

In Greenough, the Supreme Court first held that a plaintiff could seek reimbursement for his  costs, attorney’s fees, and reasonable and necessary expenses in bringing a case on behalf of others 105 U.S. at 537. But, at the same time, the high Court also stated that “there [was] one class of allowances” that was “decidedly objectionable.” -- the plaintiff’s “personal services and private expenses.” Id. 

Three years later, in Pettus, the Court again held that a plaintiff representing others in an equity suit could claim “expenses incurred in carrying on the suit and reclaiming the property . . .” 113 U.S. at 122. As in Greenough, the representative plaintiff could not claim his personal compensation out of the common fund recovery. Id.

Relying on  Greenough and Pettus, the Eleventh Circuit concluded that “the modern-day incentive award” was akin to either a salary which is earned or a bounty to be won, both of which were forbidden by two 19^th century cases. Slip Op. at 23.

The Eleventh Circuit noted that Rule 23 practice and “inertia” had resulted in incentive awards as being “commonplace in modern class-action litigation,” but added “that doesn’t make them lawful, and it doesn’t free us to ignore Supreme Court precedent forbidding them.” Id. at 25, 28.

In dissent, Judge Martin argued that the 11th Circuits own prior cases required the panel “to determine whether the incentive award [] is fair,” and concluding that the $6,000 award was fair. Id.

This opinion creates a clear circuit split – which the panel recognized – and will be top of mind with every class-action lawyer in the country.  Incentive fees have become boilerplate in insurance class action settlements; some empirical research indicates 90% of consumer class actions contain incentive fee awards, which average slightly more than $4,000 per plaintiff.  The empirical evidence suggests that Judge Martin's conclusion - that the district court did not abuse its discretion in awarding $6,000 - was in line with common practice.  

While the focus of this blog is typically business insurance, we will continue to monitor this case as it moves ahead for three reasons:  

1. Insurance companies continue to face class actions against themselves for their own business practices, making this case relevant to them. 
2. This case has major implications for this blog's readers; which include many businesses which could face class action litigation. If courts begin to disallow class action incentive fee awards, plaintiffs' firms will have a harder time finding people who are willing to sign up for the burdens of serving as class representatives (being subject to discovery, depositions, mediations, and court appearances) when the representatives could get the exact same compensation by merely being an unnamed class members.
3. Finally, we routinely advise clients regarding insurance coverage issues for class actions and are currently representing defendants in nearly a dozen high-stakes class actions.  While Johnson v. NPAS Solutions is technically a decision regarding civil procedure, it has major implications for both policyholders and insurers.   

What’s next?  Plaintiffs and Defendant could petition the Eleventh Circuit for en banc review.  But en banc petitions are granted less than 1% of the time. Because this opinion creates a circuit split, the Supreme Court may grant review.   But if neither en banc review nor certiorari to the Supreme Court are granted, the opinion will stand. In that event, the 11^th Circuit will be seen as a less-favorable jurisdiction for class actions, and class action objectors in all other circuits will start citing to Johnson.

Is the Owner-Manager of your Vendor your “Employee?”

Expansion of Coverage: North Carolina Crime Coverage Part:  Embezzlement

Is the Owner-Manager of your Vendor your “Employee?”

            On November 14, 2014, the Eastern District of North Carolina entered summary judgment in favor of an insured seeking coverage for embezzlement for actions by owners of a vendor. Colony Tire Corp. v. Fed. Ins. Co., No. 2:15 CV 27, 2016 WL 6683590 (Nov. 14, 2016 E.D.N.C.)

            The insured was seeking coverage under a claims-made policy for theft that occurred between 2002 to 2014.  The embezzlement losses were approximately $492,350.00.  The insurer denied coverage claiming that Colony, the insured, could not establish that the loss was caused by an “Employee” under the Policy.

            The money was stolen from Colony through its payroll and tax vendor, Employee-Services.Net (“ESN”).  Through the contract between ESN and Colony, ESN was allowed to withdraw funds from a designated bank account to pay Colony’s payroll and taxes.  Owners/Managers/Principals of ESN, James Staz and William Staz (collectively “the Stazes”) pled guilty to embezzling over $14 million from ESN’s many clients, including Colony.

            Essentially, the Stazes would withdraw money from Colony’s account, claiming that the money would be used to pay payroll taxes.  In reality, the taxes would go unpaid, and the money would fund the Stazes’ extravagant lifestyle, which included alcohol, strip clubs, jewelry, a luxury car, and a luxury home “with a lavish three-tiered pool, a cascading waterfall, wet bar, and dining area.”

            The critical issue for the court was whether the Stazes were “Employees” under the policy.  In the policy, the definition of Employees included “contractual independent contractor.”  In the definition, “contractual independent contractor” had to be a natural person.  Thus, from the outset, ESN, as a business entity, could not be a “contractual independent contractor.”  Further, to qualify as a contractual independent contractor, there had to be a written contract between Colony on one hand, and on the other hand either (a) the natural person or (b) an entity “acting on behalf of” the natural person.

            The written contract was between Colony and ESN.  The Stazes were not a part of the contract.  Thus, to qualify as “contractual independent contractors,” the court had to determine whether ESN was an entity “acting on behalf of” the Stazes pursuant to part (b) of the definition.

            The court interpreted the phrase “acting on behalf of” broadly due to its ambiguity.  Thus, not only did the phrase mean to act within the scope of a formal agency relationship, the Court also construed the phrase to mean actions in the general interest of or in the general benefit of the natural person.  Given this broad definition of “acting on behalf of,” the Court determined that ESN acted on behalf of the Stazes when it contracted with Colony.  Thus, the Stazes were Employees as defined by the policy.  Because they were Employees, there was coverage for the loss and directed the insurer to pay the loss.  The Court then directed the insured to prepare additional briefings on potential costs, attorney’s fees, and interest that it sought through its prayer for relief.    

            An important portion of the analysis, in our opinion, was the Court’s use of the Federal indictment for the Stazes.  Using the facts of the indictment, the Court concluded that ESN’s purpose was to facilitate the Stazes’ embezzlement scheme.  No one, other than the Stazes, benefited from ESN’s existence.  Further, the Court emphasized that ESN was a tool used by the Stazes for their criminal actions:  “the Stazes “through [ESN] defrauded ESN clients.” Id. at *5 (emphasis in original).  While not explicitly done in this case, such findings could support a veil piercing theory under North Carolina law, which would yield similar results through equitable means. 

            Given the results of this case, it would not be surprising to see a re-write of the “contractual independent contractor” provision in the future.  However, litigators could also distinguish this case on the basis of the facts.  The facts in the indictment supported showing that the Stazes used ESN for their exclusive, personal benefit.  One could potentially argue that similar facts, establishing this high-bar, close to a veil-piercing standard, would need to be found in order to meet the burden of “acting on behalf of” language.  This would be distinguished from actions by a "lone wolf" employee at a vendor who steals funds without benefiting the owners. 

Steps to effectively cancel an insurance policy

The North Carolina Court of Appeals recently released an unpublished opinion further illuminating how insurers can effectively cancel worker's compensation policies.  However, nothing in the case limits its application solely to workers' compensation (or assigned risk workers' compensation policies).  As a result, this case gives some guidance to insurers who wish to effectively cancel policies of all sorts of insurance for any valid reason (such as payment of premium).    

In McNeill v. McNeill, Travelers provided a worker's compensation policy to the employer.  Pursuant to the policy's terms and North Carolina statutory law, Travelers then requested certain information from the employer, including its IRS 1040 and Schedule C tax information.  After two months elapsed, and because the employer had not responded with any information, Travelers sent a cancellation letter to the address on the policy (certified mail, return receipt requested), giving notice that the policy would be cancelled in four weeks.  The certified mail indicated that the cancellation letter was delivered. 

During the case, the parties deposed Betty Hurst of the North Carolina Rate Bureau.  She testified that this was an assigned risk policy, and that Travelers' request for the employer's 1040 and Schedule C forms were "typical" and allowable under the North Carolina Workers' Compensation Assigned Risk Plan. 

The Court of Appeals explained that, under N.C.G.S. 58-36-105(a)(2), an insurer may cancel a worker's compensation policy if the insured commits an "act or omission . . . that constitutes material misrepresentation or nondisclosure of a material fact in obtaining the policy, continuing the policy, or presenting a claim under the policy."  To effect the cancellation, the insurer must follow the steps of N.C.G.S. 58-36-105(b). 

The Court then applied North Carolina Rule of Civil Procedure 4 (specifically, Rule 4(j2)(2) to the insurance cancellation statute, and concluded that the insurer sending a cancellation letter, via certified mail, to the employer's last known address (which was the same as the address appearing on the policy), and the letter being received, was sufficient under Rule 4 and N.C.G.S. 58-36-105 to effect a cancellation of the policy.   

Further, the Court stated that "it does not offend these principles [of administrative law or the law of the Industrial Commission] to hold that Travelers cancelled Defendant's workers' compensation policy for his failure to produce 1040 and Schedule C forms."

Because this opinion is an unpublished opinion of the Court of Appeals, reported pursuant to North Carolina Rule of Appellate Procedure 30(e), it is non-binding on future panels.  Specifically, "an unpublished decision of the North Carolina Court of Appeals does not constitute controlling legal authority."  However, citation is still allowed under Rule 30(e)(3) if there are no other published opinions on a material issue in a future case.  There is nothing in this opinion that should limit its application solely to workers' compensation cases.  Because the issue of effective cancellation of insurance policies frequently comes up, this case may prove important for practitioners in the future. 

Late notice to insurer costs Maryland bank millions

Insurance law generally imposes on a policyholder the duty to give timely notice of claims to its insurance company. Sometimes, because of forgetfulness, ignorance, neglect, or a number of other reasons, companies fail to immediately give notice of loss and potential losses to insurers. In those circumstances, insurers often raise the defense of “late notice.” As a result, a number of courts have devised a “notice prejudice rule” which limits the use of the late notice defense to situations when the delayed notice actually caused prejudice to the insurer.

In St. Paul Mercury Insurance Company v. American Bank Holdings, Inc., the Fourth Circuit, applying Maryland law, addressed the question of what qualifies as “prejudice.” In that case, American Bank Holdings, Inc., did not provide notice to its insurer until after a $98.5 million default judgment had been entered against it in the underlying claim. St. Paul raised the defense of late notice, argued that it was prejudiced, and denied coverage.

 Although the bank was eventually successful at overturning the $98.5 million default judgment, it still spent $1.8 million resisting collection on the judgment and having the judgment set aside. All of this was because the underlying complaint had been served on the bank’s CFO, who had left employment at the bank. Another officer later found the complaint and transmitted it to an outside lawyer, who claims he never received the complaint. This procedure was described by the district court as “a variety of screw-ups” such that “significant suit papers that should have gotten immediate attention didn’t.” Writing for a unanimous panel, Judge Niemeyer of the Fourth Circuit explained that “corporate screw-ups” are not a basis to excuse the failure to give timely notice to an insurer, if the corporation expects to be indemnified for the defense of the claim.

 “Actual prejudice” was shown in this case by the insurer, because the bank’s failure to give timely notice prevented the insurer from selected counsel, consulting with counsel on the defense of the claim, prevented the timely raising of a personal jurisdiction defense, and prevented the possibility of settlement discussions with the underlying plaintiff either prior to the entry of default judgment or prior to the expenditure of $1.8 million spent to resist and set aside the default judgment. These were all rights which the insurer has under the insurance contract, and all rights which it was not able to exercise because of the bank’s failure to give timely notice. As a result, actual prejudice was shown and St. Paul's declaratory judgment was granted on the basis that it had no duty to pay for American Bank's defense costs.

Long tail claims and "ancient documents" - revisions to Rule 803(16)

Companies and institutions with long-tail claims – think asbestos, pollution, and sexual molestation – sometimes become involved in bet-the-company insurance coverage litigation. Faced with a barrage of tort lawsuits, the company turns to the liability insurers it has used for decades. If the insurers are successful in denying coverage, the company may face insolvency. Determining the presence and applicability of coverage requires establishing that the company purchased liability insurance in the 1960s, 1970s, and 1980s, and what the terms and exclusions of those policies were. In those coverage cases, the terms of paper documents that have been stuffed away in filing cabinets since Watergate and the Vietnam War, become the key pieces of evidence.

  However, an influential committee of federal judges has initiated the process of removing the exception for ancient documents from the Federal Rules of Evidence. More specifically, the Judicial Conference Advisory Committee on Evidence Rules, a subcommittee of the Committee on Rules of Practice and Procedure (itself a subcommittee) of the Judicial Conference of the United States has proposed amendments to Federal Rule of Civil Procedure 803(16) and is accepting public comment and taking testimony regarding its deletion. This rather innocuous proposal may have major ramifications for insurance coverage lawyers.

Under the proposal from the Advisory Committee on Evidence Rules, Rule 803(16), the hearsay exception for “ancient documents,” would be deleted. Under current Rule 803(16), if a document is more than twenty (20) years old, and appears authentic, it is admissible for the truth of its contents. Although the rational for the ancient document exception is shaky – merely because something is old is no reason to believe it is more likely to be true – the inclusion of a hearsay exception for ancient documents is pragmatic. Often, it is simply implausible or functionally impossible to locate a witness who can testify with first-hand knowledge about a document that is decades old.

According to the Advisory Committee on Evidence Rules, the growing presence of electronically stored information, which will be easily retained in excess of 20 years, will lead to the abuse of Rule 803(16) to admit unreliable hearsay in the future.

Simply put, policyholders with long-tail claims, be they pollution, asbestos, or any other, often rely on ancient documents in proving those claims. Coverage disputes involving ancient insurance policies often rely on fractions of a complete insurance policy, and expert witnesses (known as “insurance archeologists”) are used to reconstruct material terms of policies from legally-sufficient secondary evidence. See, e.g., Dart Industries, Inc. v. Commercial Union Ins. Co., 28 Cal. 4th 1063 (2002).

The commercial reality is that insurance companies are not required by law, in most jurisdictions, to retain a copy of the policies of insurance which they issue. Instead, that burden rests on the policyholder. This is particularly true in the event that the policyholder becomes the plaintiff in a civil action, which carries the burden of proof. In those instances, the policyholder and the insurer may have to use accounting entries, check registers, stray portions of policy pages, the declarations page, or correspondence with insurance brokers in order to prove or disprove the existence of a policy and its material terms.

In current practice, witnesses with knowledge who can testify about these records are often unavailable because of lack of memory, the inability to locate a particular witness, or death. As a result, Rule 803(16) provides an exception to the hearsay rule to allow admissibility of these documents. If the proposed abrogation of Federal Rule 803(16) is approved (and eventually incorporated into the Federal Rules of Evidence), a party attempting to prove the contents of an insurance policy from the 1970s will be required to produce a witness or additional business records which confirm that the proffered policy is a business record which was made at or near the time indicated on the document in the regular course of that enterprise’s business. Rule 803(6).

Deletion of Rule 803(16) from the federal rules of evidence will also make the forum battle in coverage actions outcome dispositive in some cases. Cases litigated in state courts, where the ancient document rules will continue to apply, will be able to prove the existence of certain policies or specific terms. Filing the same case in federal court federal court would be a non-starter and perhaps sanctionable under Rule 11 if the plaintiff knew the case would rely on ancient insurance policy documents for which the attorney knew no sponsoring witness or associated business records were available to support.

Because long-latency claims continue to haunt companies, insurers, and the court system, there is still a role for the ancient documents exception in the Rules of Evidence. Although the period for public written comment has closed, public testimony will be taken. You can find the dates and details of public hearings here. In addition to a number of lawyers, seven sitting United States Senators have written to oppose the abrogation of the ancient documents exception.

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.

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?

"Shadow insurance" captive life insurer class actions to be "heard in tandem" by Second Circuit

Yesterday, the Second Circuit issued an Order in Maria Del Carmen Robainas v. Metropolitan Life Insurance Co., 15-3504 (Dkt. 46) that the three pending XXX/AXXX life insurer class actions would be heard "in tandem."

Previously, as we reported last week, the Plaintiffs-Appellants in three cases (which were all dismissed for lack of standing at the District Court level), filed unopposed motions to consolidate the three appeals.

The three cases are:

• Yale v. AXA Equitable Life Insurance Co. No. 15-2665,
• Robainas v. Metropolitan Life Ins. Co. No. 15-3504, and
• Yarbrough v. AXA Equitable Life Ins. Co., No. 15-3553.

Under Federal Rule of Appellate Procedure 3(b)(2), separate cases can be joined or consolidated on appeal "[w]hen the parties have filed separate timely notices of appeal." This rule of appellate procedure does not give any guidance to a court as to the proper reasons for consolidation on appeal. The Advisory Committee note states that "In consolidating appeals the separate appeals do not merge into one. The parties do not proceed as a single appellant."

After denying the unopposed motion to consolidate, the Second Circuit explained that "the appeals will be heard in tandem." Thus, each appeal will remain a separate appeal, the parties will comply with the briefing requirements under the Yale, No. 15-2665 case. Both 'sides' of the case, can elect to file a single brief addressing all three appeals, and a single copy of that brief and its relevant appendix would then be filed in the other two cases. Finally, the Clerk's office will set all three cases for argument before a single three-judge panel.

By rejecting consolidation, each Plaintiff-Appellant is allowed to rely on unique differences in the pleading (the Complaint) in his or her case. The factual record for each appeal will be unique to that case. If the cases were consolidated under Federal Rule of Appellate Procedure 3, then the record/Joint Appendix would be unified. However, the Court's ruling that the cases will be heard in tandem allows for uniform consideration of the common issue(s) of law, while allowing the factual/pleading portion of each case to be independent.

Also noteworthy about the Order is that the Plaintiffs-Appellents' opening brief(s) "are due thirty days after the Supreme Court issues a decision in Spokeo, Inc. v. Robins, 742 F.3d 409 (9th Cir. 2014), cert. granted, 135 S. Ct. 1892 (U.S. April 27, 2015)(No. 13-1339).

Spokeo was argued on November 2, 2015. As a recent article by Lee Epstein, William Landes, and Judge Richard Posner, published in the Duke Law Review notes, the Supreme Court usually issues a decision within three months of oral argument, occasionally will a case take up to six months to be decided, and practically all opinions are released by the following June when the Court closes for its summer recess. The Best For Last: The Timing of U.S. Supreme Court Decisions, 64 D.L.J. 991, 993 n 5 (2015). So, it's likely that we will see the Spokeo opinion released in early February, at which point the opening briefs in these appeals will be due one month later. This briefing schedule gives both Appellants and Appellees plenty of time to find amicus party assistance if they desire.  At the absolute latest, the Spokeo opinion should be public by late June 2016 (which is the conclusion of the Supreme Court's October 2014 term).  

Has North Carolina Always Had Cumis Counsel?

Recently, the insurance industry was reminded of the limitations of a reservation of rights letter by the Nevada Supreme Court’s opinion in State Farm Mut. Auto Ins. Co. v. Hansen, 131 Nev. Adv. Op. 74, (9/24/2015) which held that a policyholder is entitled to have its insurer provide independent counsel when the insurer and insured have opposing legal interest; i.e., when coverage is being provided under a reservation of rights letter.  When the insurer issues a reservation of rights letter, Nevada law now requires the insurance company to defend the policyholder by allowing the policyholder to select its own counsel, at the insurer’s expense.  This was held to be an expansion of the well-known Cumis counsel rule – that an insured has a right to independent counsel at the insurer’s expense when a conflict of interest appears – which originated in San Diego Navy Fed. Credit Union v. Cumis Ins. Society, Inc., 162 Cal. App. 3d 358 (1984). 

However, there is long-standing authority in North Carolina for a similar rule of law. The North Carolina courts have made it clear that an insurer which refuses to defend an action against its insured, when coverage is in dispute, does so at its own risk. To reduce that risk, insurance companies often defend under a reservation of rights, which is generally required to prevent the insurer from being estopped to deny coverage under the policy once the defense is conducted with knowledge of facts taking the loss outside of the coverage of the policy.

As the North Carolina Court of Appeals stated in National Mortgage Corporation v. American Title Insurance Company, 41 N.C. App. 613, 255 S.E. 2d 622 (1979), such a “conditional tender of defense does not absolve [the insurer] of its contractual duty to defend an action for a loss within the coverage of the policy…[The insured] is not required to accept a defense rendered under a ‘reservation of rights.’” Id. at 624.  Although this opinion was later overruled on other grounds by the North Carolina Supreme Court (finding that the policy did not cover the insured), the Supreme Court opinion made no mention of attorney’s fees or independent counsel.  

In the National Mortgage case, the Court held that the Plaintiff was entitled to reject the conditional offer by the insurance company and to seek indemnity for the costs of defending that action. As such, this case has been cited by litigants for the proposition that where the insurance company offers to defend under a reservation of rights, the insured is entitled to hire its own counsel and to have that counsel paid for by the insurance company.

As a result of National Mortgage Corp., insurers in North Carolina must be careful if reserving rights. If they defend under a reservation of rights in North Carolina, they may be faced with an argument that (1) a conflict of interest has arisene, (2) that the insurer’s panel counsel cannot be used, and (3) that they will have to indemnify the policyholder for its choice of counsel. 

Five Important Lessons on North Carolina Insurance Law from New NCG, Inc., Part 2

Previously, we explained in Part 1, the facts behind New NGC, Inc. v. ACE American Insurance Co., et. al, 3:10-CV-00022-RLV-DSC, 2015 WL 2259172 (W.D.N.C. May 13, 2015), as well as its application of West American Insurance Co., Plaintiff, v. Tufco Flooring East, Inc., 409 S.E.2d 692 (N.C. App. 1991) and how coverage in a putative class action can be driven by unnamed class plaintiffs and is not limited exclusively to the named class representative.

The third major takeaway from New NGC is that while insurance companies often argue that their duty to defend is determined by the allegations in the Complaint, the North Carolina Supreme Court has stated unequivocally that an insurer’s duty to defend may still be found where the insurer “knows or could reasonably ascertain facts, that if proven, would be covered by the policy.” Waste Management of the Carolinas, Inc. v. Peerless Ins. Co., 340 S.E.2d at 374, 379 (N.C. 1986). However, while the inverse of this proposition has not been addressed by the North Carolina state courts, it has been explicitly rejected by the Middle District of North Carolina in a decision in the Fourth Circuit Court of Appeals in St. Paul Fire and Marine Insurance Co. vs. Vigilant Insurance Company, 724 F.Supp. 1173, 1179 (M.D.N.C. 1989), aff’d. 919 F.2d 235 (4th Cir. 1990). In other words, the North Carolina courts will in all likelihood refuse to allow evidence outside the pleadings to negate allegations in the Complaint.

Fourth, the duty to defend only arises when the insurance company receives actual notice of the underlying action.

Fifth, a policyholder does not have to provide “specific citations to insurance policies and years of coverage for tender of notice to be proper as to the underlying claims” absent an express requirement in the policy. Memorandum and Order at 26. Instead, once notice of an underlying action is provided, it is up to the insurance company “to review the underlying suits and determine what obligations it may owe to [the policyholder]” under any and all actual policies issued by the [insurance company], whether cited by [the policyholder] or not.” Memorandum and Order at 26.

If you have questions about the scope of the duty to defend in North Carolina, please let us know.

XXX/AXXX life insurer class action appeals likely to be consolidated

We previously reported how life insurers were successful in winning dismissal of two putative class actions filed in the Southern District of New York. 

Both cases challenged the use of certain Regulation XXX/AXXX reinsurance transactions issued to life insurers by life insurer-owned captive insurance companies.  Both of those cases were dismissed under Rule 12(b)(6), for a lack of standing, because the plaintiffs failed to articulate any personal injury or actual harm in their allegations against the life insurer defendants. 

Robainas has been appealed by the plaintiffs to the Second Circuit Court of Appeals.  In a related case, Yale v. AXA Equitable Life Insurance Co. (No. 15-2665, 2d Cir.), the Plaintiffs-Appellants have moved to consolidate their case with Robainas v. Metropolitan Life Ins. Co. No. 15-3504 and Yarbrough v. AXA Equitable Life Ins. Co., No. 15-3553.

The motion was unopposed, so it is expected that the motion to consolidate and adopt a uniform briefing schedule will be granted.

The motion to consolidate also notes that "the dispositive legal issue in all three cases may be significantly shaped by the pending decision in Spokeo, Inc. v. Robins, No. 13-1339, 2014 WL 1802228 (U.S.) cert. granted, 135 S.Ct. 1892 (2015), which involves the scope of Congressional authority to create Article III standing by virtue of a federal statute authorizing a private right of action."  Spokeo was just argued on November 2, 2015 so it is unlikely that we will see an opinion issued by the end of the year.

Each of these putative class actions alleged that the life insurer defendants violated New York Insurance Law Section 4226, which entitles policyholders of life insurance or annuities to recover a statutory penalty if the life insurer makes any "misleading representation" or "misrepresentation" concerning its financial condition or reserves.  The plaintiffs allegations - closely following the Shining a Light on Shadow Insurance report published by the New York State Department of Financial Services - that certain life insurers used captive reinsurance transactions under Regulations XXX/AXXX to artificially inflate their financial position.  What the Plaintiffs did not - and could not - allege was any concrete and personal harm or injury-in-fact which they had suffered. 

We will be watching these cases closely and regularly reporting on developments.   

A rare insurance coverage defendant class action lawsuit in Ohio

Law360.com recently published my article on The Medical Protective Company v. Center for Advanced Spine Technologies in its Expert Analysis section. 

This is not the first time I've written on the topic of defendant class actions.

As readers of this blog will know, it is not uncommon for insurers to file declaratory judgment actions in federal court against a policyholder to determine coverage obligations.  Courts even explicitly sanction or advise insurers to file declaratory judgment actions when coverage is questionable.  These coverage cases often include litigating the question of whether a duty to defend exists and whether there is any obligation to provide indemnity to a policyholder.

Occasionally, questions arise as to who is a necessary party in the coverage action.  We blogged about that several weeks ago, as reflected in a recent (and I believe, ongoing) case in North Carolina.  http://wombleinsurance.blogspot.com/2015/10/scottsdale-ins-co-v-b-fitness-center.html  In Scottsdale Insurance v. B&G Fitness Center, the injured tort plaintiffs from the underlying state court action were found to not be required under Federal Rule of Civil Procedure 19 to be parties in the coverage action. 

Contrast that with The Medical Protective Company v. Center for Advanced Spine Technologies, Case No. 1:14-CV-5, United States District Court for the Southern District of Ohio.  There, the insurer specifically wanted to include all possible known and future claimants against Dr. Durrani and his practice and have them bound by the judgment. Dr. Durrani — as a result of fleeing to Pakistan and refusing to participate in American civil  litigation — was not expected to defend the insurance coverage declaratory judgment and thus the future claimants were necessary parties. A defendant class action under Rule 23(b)(2) was the procedural tool that the insurer used to include those parties.

After the defendant class was certified - containing all known patients of Dr. Durrani's practice - the court also ruled that Dr. Durrani and his practice are waived and are estopped from asserting their consent to settle rights under the policy.  This frees the insurer to mediate and settle claims under these policies without Dr. Durrani’s participation and shields the insurer from potential bad faith liability. The Medical Protective Company v. Center for Advanced Spine Technologies, (Sept. 23, 2015, S.D. Ohio).

North Carolina's modern Incorporated Cell Captive statute should allay Fitch's fears

Recently, Fitch announced its new views regarding credit risks it believes may be inherent in protected cell captive insurance companies ("PCCs").  This questioning of the structure of PCCs is in light of Pac Re 5-AT v. AmTrust North America, 2015 WL 2383406 (D. Montana, May 13, 2015 ).

A protected cell company is a captive insurance company composed of (1) a “core” and (2) a number of “cells” which are established around the core.&nbs;Unless limited by statute or regulatory rule, there can be an unlimited number of cells.&nbs;The assets and liabilities of each cell are segregated from the assets and liabilities of every other cell, as well as from the core.&nbs;The PCC structure was designed so that the assets of each cell are only available to creditors of that cell.&nbs;  Once a PCC is established by a sponsor, the sponsor can then operate each cell as an independent insurance company.&nbs;Or, more commonly, the sponsor can operate the core and other, non-related companies can operate each cell as independent insurance companies.&nbs;The cell structure – and its shared overhead – permits smaller companies who do have the capability or desire to operate a single parent captive insurance company to obtain some of the benefits of captive insurance.&nbs;

In Pac Re 5-AT v. AmTrust, a contract dispute regarding a captive reinsurance agreement between a cell and its reinsurer (which was subject to arbitration) broadened into an issue of first impression regarding protected cell companies.   Originally, the dispute was between the reinsurer and the one single protected cell (Pac Re 5-AT a/k/a Cell 5) under the terms of the captive reinsurance agreement.  However, the reinsurer named both the cell and the core (Pacific Re, Inc., a Montana captive insurance company) as a party as well.  Pacific Re then sought a declaratory and injunction in federal court that it was not a party to the arbitration. 

On cross motions for summary judgment, the court applied Montana’s corporate law to its captive insurance enabling statutes (which established protective cell captive insurance companies).&nbs;

Stating that this was an issue of first impression under Montana law (and indeed, an issue of first impression under all domestic United States law), the court stated in pertinent part:

The statutory construction issue arises here because a cell is not a separate de jure legal entity, but has many de facto aspects of a legal identity.&nbs;It is clear that the liabilities and assets of a protected cell are segregated from the other cells and from the PCC, but it is also clear that a protected cell does not have a separate legal identity.  Each cell, in essence, operates as its own separate entity, but remains part of the larger PCC.&nbs;Though the statute does not contemplate that the assets of a protected cell will be used to satisfy the liabilities of any other cell, the cells are not entirely independent from the PCC.

The court went on to rule that:

 “A protected cell is not a separate legal person.&nbs;Without a separate legal identity, and absent a statutory grant to the contrary, a protected cell does not have the capacity to sue and be sued independent of the larger PCC.&nbs;The statutory language is clear, and the court may not look beyond the plain meaning.&nbs;Although a protected cell has many attributes of independence from the PCC, it remains a part of the PCC, which has the capacity to act on behalf of the protected cell as in this instance Pacific Re acted on behalf of Cell 5 in agreements at issue.”&nbs;

In summary, “Pacific Re, as the PCC, entered into contracts at issue, both on its own and on behalf of the protected cell.&nbs;It is properly before the arbitration tribunal and will appropriately be bound by the results of the arbitration.”

As Fitch points out, the Pac Re 5-AT opinion raises significant concerns regarding how well "ring-fenced" each cell in a PCC is, and what would happen to a cell if another unrelated cell caused the core of a PCC to become insolvent. 

North Carolina recently revised its captive insurance statute with a number of technical corrections.  Under N.C.G.S. § 58-10-510, “a protected cell captive insurance company licensed under this Part may establish and maintain one or more incorporated or unincorporated cells, to insure risks of one or more participants. . . [ subject to certain conditions].”

Section 58-10-512 goes on to outline in more detail the formation, operation, and obligations under an incorporated cell captive program.  This passage deals squarely with the issue raised by Pac Re 5-AT .  The statute specifically states that:

"In the case of a contract or obligation to which the protected cell captive insurance company is not a party, either in its own name and for its own account or on behalf of a protected cell, the counterparty to the contract or obligation shall have no right or recourse against the protected cell captive insurance company and its assets other than against assets properly attributable to the incorporated protected cell that is a party to the contract or obligation."

As Pac Re 5-AT shows, understanding the applicable corporate law and captive insurance law of any domicile is important not just to those operating PCCs, but to anyone dealing with them as well.