Pitfalls That Can Derail Insurance Coverage Disputes

Insurance coverage disputes have a lot of commonalities. And lawyers who represent both sides of the table – defense and plaintiff – say participants in such disputes should be aware of certain potentially adversarial issues that routinely arise in the course of a court challenge to an insurance claim.

Among those common issues that could potentially and unnecessarily complicate or derail a dispute over insurance coverage are discovery, expert witness, late notice, duty to cooperate, consent to settle, collusion, and reimbursement of defense costs.

In discovery, context and quantity matter, according to Matthew Foy, an insurance defense attorney with Gordon & Rees LLP, a national law firm based in San Francisco.

“Something that is discoverable in the context of a bad faith case is not going to be discoverable in my view in a simple declaratory relief action in a simple breach of contract case,” Foy said during a panel discussion on insurance litigation disputes at the Risk and Insurance Management Society (RIMS) conference in Los Angeles.

And a lot of discovery requests are unnecessary and counter-productive.

“I’ll get requests for underwriting files, the claims manual, the underwriting manual, reserve information, all the reinsurance information, and so and so forth,” Foy said. “I know the intent behind that effort is really to put a lot of pressure on the insurance company, get it up to the higher reaches of the insurance company, get them taking notice in the hopes that it will give the insured more leverage. In my view it tends to backfire.”

William Passannante, a plaintiff lawyer and partner Anderson Kill & Olick PC, said while “an abundance of discovery, which is always fun for the outside lawyers, may not make sense. And it’s something that requires an educated customer on both sides.”

Foy said there are cases in which a lot of discovery is appropriate, but not every case warrants it. Far-flung discovery often is unnecessary may only serve to create animosity on both sides of the table.

“One of the things that lawyers sometimes forget is that the person we are asking to make the determination of whatever the question is … is a human being” with word to do, said Passannante, who also participated in the litigation panel. “Are you going to focus the dispute to get the judge to answer the question, or are you going to bury the judge in three years’ worth of discovery?”

In some cases discovery is necessary, appropriate and proper, but in order for it to be effective, “you really have to know how to pick and choose,” he said.

In many coverage cases one side or the other, or both sides, may hire an expert witness to testify on underlying facts of the case.

“Let’s say it’s a coverage case involving asbestos exposure,” Passannante said. “You have an expert to testify about the nature asbestos injuries proving that you trigger multiple policies.”

Or in a claim over bad faith, an expert may be called in to look at the claims file and make a determination.

“Those are very common” Passannante said, and “even if you don’t hire the experts you need to be aware right at the beginning what the elements of proof are and if you need experts and where you’re likely to need them.”

In bad faith causes of action, however, the use of experts may not be allowed and may even backfire, Foy said.

“One thing that I see in cases that go to trial in a bad faith cause of action … is the plaintiff side will try to put in an expert witness on policy interpretation. I’d say 75 percent of the time I’m successful in keeping out that testimony. The reason for that is expert witness testimony is supposed to be on a topic that is outside the general knowledge or general knowledge of prior fact. What words in a policy mean, we don’t need expert testimony for that.”

What often happens when experts are called on to testify on policy language, Passannante said, the judge will look at both the plaintiff and defense lawyers and say: “I understand words, and I’m the judge; I get to interpret the words.”

“The late notice point is fairly simple,” Passannante said. “Free advice: give notice … if you want your insurance, give notice. Notice is not like fine cheese, it’s not like good wine – it does not get better with age.”

Claims made and property policies have “very scary looking deadlines,” Foy said. However, on liability policies “you have the advantage of what is called the prejudice rule … which often means despite late notice you may still get coverage.”

Even so, Passannante said, there will still be an argument over whether there is prejudice or not. “Why do I want to have that fight for want of an email? Send that email.”

With notice, there is also the issue of who within a company has the responsibility to give notice of a claim to the insurance company. And a lot of policies are specific as to who that person should be, Foy said.

In most cases, particularly for large organizations, the responsible person would be the risk manager or general counsel, Passannante said, “not just some mid-level manager in some far off division.”

The late notice problem “shows up far more often than I’d ever believe,” Foy said. “And it’s not usually because somebody at a lower level did not send notice.”

Insureds have a duty to cooperate in claims investigations under cooperation clauses contained in insurance policies, Foy and Passannante said.

“This comes up in several circumstances where the insurance company is assessing whether the insured is covered and often whether an exclusion applies,” Foy said. “When I advise my clients I tell them not to send a list of 15 to 20 informational questions, but if there’s a legitimate need for information to determine whether or not a particular claim is covered or potentially covered, the insurance company under a lot of policies includes a provision that says the insured has to cooperate in an investigation and settlement.”

What happens if the insured does not cooperate with the investigation “depends on how egregious the circumstance is,” Foy said. “More often than not if the insured is not cooperating in providing information we’ll go to court and try to get them to cooperate.”

Non-cooperation on the plaintiff side usually arises not with the risk managers, “it’s the lawyers – the in-house counsel and the outside counsel.” They look at the insurance company’s request and say “‘darn them they’re not entitled to anything,’” Passannante said. “‘They didn’t acknowledge coverage. Tell them to go take a long walk off a short pier with their information request.’”

There are two different types of consent to settle clauses, Foy said. In the commercial general liability policy, “where the insurance company picks up the defense the insurer is typically going to have the right to settle or not settle a case.”

Many directors and officers (D&O) and professional liability policies, however, “give the insured the right to veto a settlement,” he said. That provision allows professional insureds to protect their reputations. “So there are these consent provisions that can go both ways,” Foy said.

Almost all policies have a provision that says “the consent to settle shall not be unreasonably withheld,” Passannante said. In order to avoid giving the appearance of breaching the policy, if you want to deny consent to settle request, you need to make sure consent was not unreasonably withheld and that the record reflects that.

“There are all sorts of ways to show that. … It doesn’t take much more than a couple of emails or letters,” Passannante said.

Although it doesn’t happen often, collusion between an insured and an underlying plaintiff in an effort to manufacture coverage is not unknown, Foy said.

It may occur when there are differences between the way a claims adjuster sees the policy and the way the insured sees the policy.

“The suddenly appearing defamation cause of action is one where I know the underlying plaintiff and the policyholder have gotten together,” Foy said. For instance, what may have been an “uncovered trademark claim on which coverage was denied, two months later becomes … a defamation cause of action.”

The danger in such collusion is that “the insurer can uncover agreements between parties that are supposed to be adversaries,” Foy said.

“In some insurance policies, most notably D&O insurance policies, this collusion concept actually makes it into one of the exclusions,” Passannante said.

In many D&O policies, “there is an insured-versus-insured exclusion designed to prevent a collusive internal lawsuit – one director versus another director – that would bring insurance money into a situation where there otherwise wouldn’t be,” he said.

In some jurisdictions insurers may seek a reimbursement of defense costs from the insured if it turns out that an exclusion is triggered in the course of litigating a claim.

“In new York, this almost never, ever happens,” Passannante said. “In some other jurisdictions, it’s a possibility.”

Foy said the practice is “allowable in California and a number of jurisdictions.” If the insurance company is defending a case in which there are multiple causes of action and one of them is potentially covered and one of them not, “the insurance company can reserve the right to seek reimbursement” for the one that is not covered.

There are also instances in which an insurance company may decline coverage but the insured counters with a reasonably valid argument that there is potential for insurance coverage. If the insurer is not really sure, they may offer to defend but reserve the right to pursue the defense costs, Passannante said.

Failure to exhaust primary coverage is not something that should happen for an insured, Passannante and Foy said. But the problem occurs when the primary insurer offers to settle a case for less than the policy limit and prevents a secondary coverage for kicking in on a covered claim.

For instance, Passannante said, a company has a $1 million primary policy but gets hit with a $10 million claim.

“The primary says – ‘oh this may not be completely covered, will you settle for $9,999,000?’” Passannate said. Then the insured agrees, thinking it’s okay since the amount only $1,000 under the limit. What it actually cost, Passannante said, was the $100 million secondary policy that won’t kick in until the primary coverage is completely exhausted.

The practice is “completely contrary to the law that has been in place in most states since 1924 or ’27 – and your brokers, by the way, should be reminded – get me good exhaustion language in my policies. It’s their job. They shouldn’t permit this to happen.”

Foy said good exhaustion language in policies is readily available, but Passannante said he’s seen policies this year without the pertinent language.

“If that happens, your broker is not doing their job,” Passannante told the audience of mostly risk managers. “You should box their ears because you are entitled to solve this non-problem.”

This article is based on a panel discussion at the RIMS 2013 annual conference: Consorting with the Enemy: What Both Sides in a Coverage Dispute Can Learn from Each Other.