Legal Spotlight: October 15, 2014
Legal Fees Must Be Returned
In the early 1990s, the O’Quinn law firm began representing women in a class-action lawsuit against breast-implant manufacturers.
As litigation continued, the firm began to allocate the general expenses associated with the lawsuits by deducting 1.5 percent of each woman’s gross recovery, even though the contingent fee contracts did not provide for such a deduction and clients were not informed of the deduction.
In 1999, a group of former breast-implant clients filed suit against the firm, alleging they were improperly charged those expenses. A similar lawsuit was filed by other former clients in 2002, and it was later incorporated into the 1999 litigation.
National Union Fire Insurance Co., which had issued a primary Lawyer’s Professional Liability policy, agreed to provide the firm with a defense, subject to a reservation of rights, and in 2001, the U.S. District Court for the Southern District of Texas, Houston Division, upheld the firm’s right to a defense, but stayed the indemnity issue. The case was later closed.
The dispute entered arbitration, which ruled in 2007 that the law firm was liable for $41.5 million for breach of contract, attorneys’ fees and interest, as well as forfeiture of $25 million of its $263.4 million fee for the underlying breast-implant litigation. The firm later settled the final award for $46.5 million in 2009.
The firm also settled with a group of insurers that had issued an excess professional liability policy in separate actions, except for Lexington Insurance Co., which was sued by O’Quinn seeking indemnification up to the limit of liability.
Lexington asked the court to dismiss the case, arguing that the policy excluded losses that consisted of fines; penalties; sanctions; reimbursement of legal fees, costs, or expenses; or “matters which may be deemed uninsurable under the law,” which includes “the restoration of an ill-gotten gain,” according to court documents.
The insurer also argued that O’Quinn’s “improper billing practices” were not professional legal services, noting that the policy covers “only those acts which use the inherent skills typified by that professional, not all acts associated with the profession.”
The court agreed that the billing practices do not require specialized legal knowledge and that the law firm had received a “profit or advantage to which [it] was not legally entitled.” It dismissed the case.
Scorecard: The insurer did not need to pay up to the limits of its excess policy liability limits for the $46.5 million in damages and fees paid by the law firm.
Takeaway: Billing practices were not covered by the “professional legal services” policy issued by the insurer.
Millions Provided in D&O Coverage
Faced with six lawsuits seeking more than $1 billion in damages from the now-bankrupt MF Global Holdings, which is accused of improperly accessing customer money to cover trading losses, executives of the company sought defense coverage from D&O and E&O policies.
In April 2012, the U.S. Bankruptcy Court in the Southern District of New York set a “soft cap” of $30 million for insureds to use for defense. In May 2013, the insureds requested additional funds and eventually the court agreed to increase the cap to $43.8 million.
Later, the insureds asked the court to focus just on the D&O primary and excess policies, and eliminate the cap altogether. They argued the D&O proceeds should not be subject to bankruptcy court oversight or limitation.
And even though the judge found the amount of money spent so far for defense was “staggering, even before the first deposition has been taken,” he agreed with that position.
In September, Judge Martin Glenn withheld only $2.5 million for self-retention and $13.06 million that is the amount of a possible claim against the D&O policies if it pays the indemnification of former CEO Jon Corzine, Bradley Abelow, former president, and ex-CFO Henri Steenkamp. That decision provides up to an additional $200 million in coverage.
Scorecard: Former executives of MF Global were given access to an additional $200 million for defense of stockholder lawsuits.
Takeaway: Insurance policies that provide exclusive coverage to directors and officers are not part of the estate for bankruptcy purposes.
Lawsuit Fires Blanks
Marion E. “Bud” Wells, the sole shareholder of SSO, a retail firearm and security safety store, and Rex McClanahan agreed in 2007 to be owners of BGS, which used to be known as Bud’s Gun Shop in Paris, Ky.
All of its employees, including employee Matthew Denninghoff, were asked to execute noncompete agreements.
About that time, Wells began to liquidate his interest in SSO via a stock purchase agreement with Earley M. Johnson II. As part of the transaction, SSO assigned the federal and state trademark rights in the Bud’s Gun Shop name to Wells, who licensed the rights back to SSO.
For a time, BGS and SSO shared a building, but in January 2009, BGS relocated to Lexington, Ky., opening its own retail store. SSO continued to supply product and fulfill orders for it, however, until April 2010.
At some point before January 2010, Denninghoff — who quit that month without notice and began working for SSO — “deliberately erased” his work email and other contents but “secretly kept” BGS’s customer database, giving them to SSO, where his sister was a vice president, according to court documents.
SSO then opened a competing online firearms operation and sent mass promotional emails to BGS customers, according to court documents. BGS sued for misappropriation of trade secrets and breach of contract, among other charges.
SSO sought defense and indemnification under its commercial general liability policy with Liberty Corporate Capital Ltd. It claimed that BGS’s accusation that it stole customer information that was used for emails fell under the “advertising idea” section of the policy.
It also argued that trademark infringement claims constitute “property damage.”
Liberty Corporate Capital sought to dismiss the request for coverage, and the U.S. 6th Circuit Court of Appeals agreed.
Electronic data is not “tangible” property, and the use of customer database information did not involve advertising ideas, it ruled.
Scorecard: Liberty Corporate Capital did not have to indemnify or defend an insured accused of theft of trade secrets.
Takeaway: Because Kentucky law did not define “advertising idea,” it must be interpreted “according to the usage of the average man.”
Legal Spotlight: October 1, 2014
Firms Given More Control Over Independent Counsel
Signal Products Inc. manufactured handbags and luggage using a design known as the “Quattro G Pattern executive in brown/beige colorways,” in accordance with its license from Guess? Inc.
In 2009, Gucci America Inc. filed suit against Guess?, Signal and others, claiming the design “infringed on a distinctive Gucci trade dress known as the ‘Diamond Motif Trade Dress.’ ” Signal’s share of the infringement claim was $1.8 million.
Signal filed suit in U.S. District Court in California after its insurers — American Zurich Insurance Co., which had issued a primary commercial general liability policy, and American Guarantee and Liability Insurance Co., which had issued an umbrella liability policy — refused to pay $1.9 million in defense costs.
Zurich countersued, seeking a summary judgment that it was not required to reimburse Signal for a $750,000 interim legal payment to the primary legal firm retained by Guess? (of a total $1.9 million in fees for Signal) or for $1.2 million in legal fees for a second law firm that represented Signal in the action.
The insurers argued they were not required to pay fees to the second law firm because Signal had already retained another law firm to represent it, and that the fees were not incurred in connection with Signal’s defense.
U.S. Judge Christina Snyder in August rejected requests from both sides for summary judgment, ruling more information was needed to determine reasonableness of legal fees and other “genuine issues of disputed material fact.”
However, she did rule, in this case of first impression, that Signal could use more than one law firm as independent counsel when there is a potential conflict of interest in insurance cases.
“Having accepted that multiple attorneys may serve as … counsel, there does not appear to be any principled grounds for requiring as a matter of law that all of those attorneys need to be employed at the same law firm,” she wrote.
Scorecard: The insurers may have to pay up to $1.2 million to the second of two law firms, in addition to possibly having to pay up to $1.9 million in litigation costs to the primary firm.
Takeaway: California law allows an insured to retain more than one law firm as independent counsel in an insurance dispute.
Attorneys’ Fees Not Included in Damages Exclusion
Both actions were settled by PNC: One in 2010 for $12 million — which included $3 million in attorneys’ fees, $77,857 in costs and expenses, and $15,000 toward incentive fees for the representative plaintiffs — and one in 2012 for $90 million, including $27 million for attorneys’ fees, $183,302 for reimbursement of costs, and $30,000 in plaintiffs’ incentive awards.
On May 21, a U.S. judge in the Western District of Pennsylvania recommended that the insurers cover the settlement costs. Both Houston Casualty Co. and Axis Insurance Co. had issued policies with a $25 million liability limit, subject to a $25 million retention.
In June, U.S. Judge Cathy Bissoon in that district disagreed. She ruled that the insurers were not responsible for the part of the settlements that returned overdraft fees to customers — since fees were excluded from the definition of “damages” in the policy.
Attorneys’ fees and costs totaling $30.3 million, she ruled, were not excluded. She ordered more proceedings on the claims expenses and damages.
Scorecard: Two insurers are responsible to cover up to $30.3 million for attorneys’ fees and costs that were included in settlements of two class-action lawsuits.
Takeaway: The fee exception to damages does not extend to the entirety of settlement costs, particularly attorneys’ fees, costs and incentive awards.
Underwriters Must Pay Recall Costs
When Abbott Laboratories agreed in December 2000 to acquire the global operations of Knoll Pharmaceutical Co., it notified its Lloyd’s of London carriers, in accordance with its product recall insurance coverage. That coverage stated the new entity would automatically be covered, but additional premiums would have to be negotiated.
As part of the negotiation with a group of underwriters led by Beazley and American Specialty Underwriters, Abbott indicated there was no “current situation, fact or circumstance” that would lead to a claim under the Accidental Contamination policy (which would include any government drug recalls).
A premium was eventually paid and accepted in July 2001, even after the company advised the underwriters that the U.S. Food and Drug Administration may pull Knoll’s popular thyroid drug Synthroid from the market.
The company and its underwriters did execute in October 2001 a “tolling agreement … that would allow the parties to preserve their rights with respect to any Synthroid-related claims.”
On March 6, 2002, the Italian Ministry of Health suspended all sales and marketing of sibutramine (manufactured by Knoll as Meridia).
Abbott filed a claim under the policy, and on May 16, 2003, the underwriters informed Abbott the tolling agreement was cancelled because Abbott “had not fully responded to their document and information request.” When it asked what information was needed, Abbott received no response.
On June 2, 2003, the underwriters filed suit to rescind the policy, while Abbott countersued for a declaratory judgment for coverage, breach of contract and “vexatious delay damages.”
A judge rejected the underwriters’ claim for recission, noting that the insurers had accepted the additional premium and that the Synthroid situation had been disclosed in a timely manner.
For damages, the court put the company’s losses at $155.2 million. Minus a deductible and 10 percent coinsurance, the underwriters were told to pay $84.5 million, plus about $2.8 million in costs and interest.
A three-judge panel on the Appellate Court of Illinois, First Judicial District, upheld that decision on appeal on July 28.
Scorecard: The underwriters have to pay $84.5 million plus $2.8 million in costs and interest.
Takeaway: By accepting the premium and failing to pursue issues of due diligence, the underwriters undercut their argument for a “material misrepresentation” by the company.
Legal Spotlight: September 15, 2014
Insurer Wins Priest Abuse Case
Between 1979 and 1986, now-former priests of the Roman Catholic Church of the Diocese of Phoenix sexually abused adolescent males. The diocese settled four sexual abuse cases, and obtained partial coverage from its primary insurance carrier, Lloyd’s of London.
Its excess liability carrier, Interstate Fire & Casualty Co., (IFC) denied the diocese’s claim. The insurer sought a declaration that it was not responsible for coverage, while the church sought $1.9 million in damages, claiming breach of contract and bad faith.
The U.S. District Court for the District of Arizona found in favor of the church, but in a 2-1 decision, the U.S. 9th Circuit Court of Appeals reversed that decision in July.
The argument came down to whether “any” means “any” or whether it means “any one,” according to the majority opinion.
The insurance policy excluded liability “of any Assured for assault and battery committed by or at the direction of such Assured … .”
The appeals court agreed with IFC’s argument that “such Assured” refers back to “any Assured” — so that coverage would be excluded for “both the insured who committed the assault and battery as well as innocent co-insureds [referring to the diocese].”
It rejected the diocese’s “effort to infuse ambiguity into an otherwise clear agreement,” according to the opinion.
In a dissenting opinion, however, Senior Judge D.W. Nelson, found the wording more ambiguous, and said there were “three possible qualities that ‘such’ can refer to,” including Assureds facing liability; the “entire class of those covered by the policy;” or “those Assureds who committed or directed assault and battery.” Thus, she would have ruled in favor of the diocese.
The case was remanded to the lower court to determine attorneys’ fees and costs.
Scorecard: Interstate Fire & Casualty Co. was not responsible for more than $1.9 million in settlement costs.
Takeaway: The decision adds uncertainty to the so-called “any insured” exclusions, which generally are interpreted narrowly.
Warranty to Repair Supersedes an Implied Warranty
Doug and Karen Crownover spent “several hundred thousand dollars” to fix problems in the foundation and HVAC system at their Texas home, which was built by Arrow Development Inc.
In its October 2001 construction contract, Arrow had provided the Crownovers a warranty to repair work, but the developer failed to correct the problems or abide by an arbitrator’s ruling that ordered it to pay damages to the couple.
Arrow later entered bankruptcy, and the Crownovers sought recovery from Mid-Continent Casualty Co., which had issued a succession of comprehensive general liability policies to Arrow from August 2001 through 2008.
Mid-Continent denied the demand for payment, citing several exclusions in the policy. The couple then filed suit against the insurer for breach of contract, and a district court in Texas granted Mid-Continent’s request for summary judgment.
It based that decision — which was upheld by the U.S. 5th Circuit Court of Appeals in June — on a contractual-liability exclusion in the insurance policy.
That clause excludes claims when the insured assumes liability for damages in a contract or agreement unless the insured would be liable for those damages absent the contract. In this case, the contractual liability referred to the warranty to repair work that was included in the construction agreement.
The court rejected the couple’s argument that Arrow was liable for the repair work in the absence of the warranty because it had an “implied warranty of good workmanship.”
In its findings, the court ruled that the arbitrator found in favor of the Crownovers explicitly based on the warranty to repair, and that an express warranty supersedes an implied warranty. The court also ruled the arbitrator’s decision was based on Arrow’s failure to repair the work, not for the work done initially.
Scorecard: Mid-Continent Casualty Co. did not have to pay “several hundred thousand dollars” to the owners of a defectively built home.
Takeaway: The ruling aids insurers fighting indemnification in construction defect cases, as it narrows the scope of the contractual-liability exclusion that had been set in a recent Texas Supreme Court decision.
Effort to Focus on Condo’s Decreased Market Value Rejected
In 2010, a fire destroyed a commercial office condominium building owned by Whitehouse Condominium Group in Flint, Mich.
The Cincinnati Insurance Co. owed Whitehouse the “actual cash value” of that building at the time of loss. The question, eventually determined by the U.S. 6th Circuit Court of Appeals in June, was how much that actual cash value amounted to.
The policy defined actual cash value as the “replacement cost less a deduction that reflects depreciation, age, condition and obsolescence.” At issue in the case was the definition of “obsolescence.”
While the insured argued the word related only to “functional” obsolescence — generally meaning something inherent to the building itself such as an outdated electrical panel — the insurance company said the word also included “economic” obsolescence, meaning a decrease in market value due to an external event.
Whitehouse said the insurer’s position was “definitional high jinks,” arguing that economic obsolescence is a “specialized concept used only in certain settings and does not fall within the general meaning of obsolescence.”
The U.S. District Court for the Eastern District of Michigan agreed with that position, ordering a summary judgment in favor of Whitehouse. On appeal to the 6th Circuit, a three-judge panel affirmed that decision.
Scorecard: The condominium association received $1.6 million more on its property claim due to the ruling.
Takeaway: When contract terms are ambiguous, the common definition applies, and in Michigan, in particular, if a term has two different reasonable interpretations, it is construed against the insurer.