Legal Spotlight: March 2014
Insurer Need Not Pay Settlement
An Indiana appeals court ruled that ACE American Insurance Inc. was not required to contribute $3 million to the settlement of an emissions lawsuit filed against Pernod Ricard USA, d/b/a Seagram Lawrenceburg Distillery.
However, the court left open whether ACE acted in bad faith in the case.
Pernod, which operated a distillery in Lawrenceburg, Ind., from January 2002 until June 2007, was sued by a neighbor, William Klepper, in a class-action lawsuit that claimed mold from the distillation process damaged nearby properties.
Pernod was insured under a commercial general liability policy by XL Insurance America from Jan. 1, 2001-2003, and by ACE from Jan. 1, 2003-2004. The ACE policy included a provision that “legally obligated” ACE to pay damages for bodily injury or property damage, as defined in the policy. It also included a “voluntary payment provision” that stated the insured should not “voluntarily make a payment, assume any obligation, or incur any expense, other than for first aid, without our consent.”
ACE agreed to contribute 49 percent of the defense costs to Pernod “under a full reservation of rights,” according to the ruling. XL paid the remainder, and in total, ACE contributed $167,965 to the costs of legal defense.
During settlement discussions, XL and Pernod asked ACE to contribute $1 million toward an agreement, but ACE set its contribution at no more than $250,000. Nonetheless, in April 2009, a settlement agreement was reached, without ACE’s involvement, that required Pernod to pay $1.2 million, XL to pay $1 million and ACE to pay $3 million.
A special master determined that ACE had honored its obligations, and that Pernod had breached its contract by entering an agreement without ACE’s consent.
A trial court agreed, but declined to enter a final judgment on all of the issues. An appeals court also agreed that ACE was not required to contribute to the settlement. However, it ruled that a final judgment on claims that ACE acted in bad faith “would be premature” at this time,” and that such a determination could be based on civil law liability, in addition to the insurance contract.
Scorecard: ACE did not have to contribute $3 million to settle allegations against a distiller accused of damaging nearby property due to mold from ethanol emissions.
Takeaway: The court expanded the ability of insureds to pursue bad-faith claims handling against carriers, by not restricting such claims to breach of the insurance contract.
Insurer Must Defend Church in Trademark Case
A church schism in South Carolina has led to a trademark infringement lawsuit filed by a breakaway diocese against the Episcopal Church in the United States — and has ensnarled an insurer that issued a commercial liability policy.
The Episcopal Church in South Carolina (TEC-SC), which broke away from the national church (TEC) in 2012 over issues including authorization of same-sex marriage, and gay bishops, filed suit to seek court authorization of its use of intellectual property, such as trade names and services.
TEC-SC then filed suit in the U.S. District Court for the District of South Carolina against Church Insurance Co. of Vermont and the Church Insurance Co., seeking indemnification and defense under its CL policy, and alleging breach of contract and bad faith.
On Jan. 6, the court dismissed Church Insurance Co. from the case, ruling there was no evidence it had issued a policy to TEC-SC.
The court also ruled the Church Insurance Co. of Vermont had a duty to indemnify and defend TEC-SC because the IP property claims created an advertising injury and potential damages, as defined in the policy.
It rejected an argument that the insurer breached its contract, but ruled there was insufficient evidence that the insurer acted in bad faith.
Scorecard: The insurance policy provides a coverage limit of $1 million for defense, and payment of claims for trademark infringement.
Takeaway: The potential awarding of attorneys’ fees are sufficient to trigger coverage for potential damages.
Oil Terminal Wins Flood Deductible Argument
A Supreme Court of New York judge agreed with Castle Oil Corp., that the company’s insurer had miscalculated the amount of a deductible following nearly $2.3 million in damages caused by Superstorm Sandy.
Castle Oil, which owns and operates a fuel oil terminal in the Bronx, had a commercial property policy with ACE American Insurance Co. in 2012.
The policy contained a $2.5 million sublimit for “flood including storm surge located in special flood hazard areas,” as defined by FEMA. The policy endorsement provided that the deductible applicable to flood loss in such areas was equal to 2 percent of the total insurable values at risk per location, subject to a minimum of $250,000.
At issue in the lawsuit filed was the phrase “insurable values at risk.”
The insurer contended that the deductible should be based on the total insurable value of the property, which was $124.7 million. That would result in a deductible of nearly $2.5 million, which is above the oil terminal’s damage amount, according to the opinion. Castle argued successfully that the 2 percent deductible applied to the $2.5 million insurable values “at risk” of flood damage — resulting in a deductible of $250,000. If that was not the case, the court ruled, the flood insurance coverage would be “illusory.”
During the litigation, ACE noted that policyholders might be able to submit a claim for more than the coverage limit and have the deductible subtracted from that amount, said Finley Harckham, an attorney and partner at Anderson Kill, who represented Castle Oil. Thus, policyholders could end up recovering the full limit of coverage without it being reduced by a deductible.
Scorecard: ACE was required to pay $2 million in damages to Castle Oil minus the deductible.
Takeaway: The value of a property for premium purposes does not necessarily equate to the value of the property’s insurable risk.
Insurer Avoids Data Breach Costs
The Connecticut Appellate Court ruled that “mere negotiations” did not fit the definition of “a suit” in a CGL policy that required an insurer to defend the insureds. The case involved the 2007 loss of computer tapes containing personal information of about 500,000 past and present IBM employees. The tapes were lost in transit.
Recall Total Information Management, which had a records storage agreement with IBM, had subcontracted with Executive Logistics to transport the data. Executive Logistics had a $2 million commercial general liability policy and a $5 million umbrella liability policy, both naming Recall as an additional insured.
Federal Insurance Co. denied coverage, and the court ruled it did not have to reimburse Recall for the $6.2 million it paid to IBM for the costs of notifying affected employees and offering credit monitoring. The insurer also said there was no “personal injury” coverage, as the policy required “publication” of the data to a third party. IBM’s lost data was never used.
Scorecard: Federal Insurance Co. did not have to pay $6.2 million following a data loss.
Takeaway: The court left open the possibility that costs to make injured parties whole by offering credit monitoring, etc., could be covered, if there is “publication” of the data to a third party.
The Gap in the Clouds
Cloud computing is integral to modern business. According to market research firm Gartner, the global cloud service industry will be worth $180 billion by 2015, while cloudhypermarket.com estimated a third of all IT expenditures in 2013 would be on cloud computing.
The cloud network is maintained by nearly 35,000 data centers (cloud service facilities containing physical servers), about 25,000 of which are located in the United States. These facilities are extremely well protected, employing the very best physical and cyber security systems, and are usually located in secretive locations away from obvious natural perils.
However, these facilities still require traditional property coverage to insure against risks including flood, fire, storm, earthquake, sabotage, civil commotion and terrorism. If one or more major cloud service facilities were damaged, service could be disrupted and data lost, with far-reaching economic implications for businesses that rely on the service.
Last year, Superstorm Sandy shut down data centers in Manhattan, while Amazon suffered two separate power outages at its Northern Virginia cloud facility forcing many popular websites including Netflix, Instagram and Pinterest offline. But it’s not just media outlets that suffer — thousands of businesses are now actively using the cloud for business purposes, with basic data storage only accounting for 13 percent of cloud usage, according to research firm IDC.
Despite growing reliance on the cloud, Florence Levy, senior vice president and head of Lockton’s Global Technology and Privacy Practice, believes there is a gap in the insurance market that could leave cloud users uninsured for lost data or business interruption in the event of a physical event damaging a cloud facility.
“Traditionally, property policies address physical triggers and harm, while cyber and even errors and omissions policies are intended to address non-physical triggers and economic damage,” she said. “In the event of a physical trigger causing non-physical harm, property underwriters and cyber underwriters will be left pointing fingers at each other.”
According to Jim Charron, Technology Practice leader for Zurich, it is possible to insure data under a property policy, although coverage language often doesn’t capture the entire exposure. “Some [policies] are very clear that they cover computing resources and will specifically state that the coverage includes voice, data and even video, while others are not,” he said. “There are requests for this exposure to be covered and underwriters are responding, but the wording isn’t always reflective of the exposures.”
Charron added that underwriting becomes even more complicated when data is being held by a third-party on behalf of potentially millions of clients.
“Traditional property and business interruption risks already existed for insureds who maintained their computing resources within their own buildings, but with the use of the cloud those risks are subject to equipment not owned by the insured. Once the risk has been transferred to another party the insurance needs to change along with that,” he said. “I think there is an opportunity for insurers to refresh their approach.”
“People are starting to realize this may be a bigger issue than we had previously allotted for in the last couple of years. Savvy clients are asking a lot of questions,” said Levy, adding that brokers are trying to encourage insurers to develop enhanced coverage to ensure cloud users’ data is properly insured.
“The market is trying to figure out a way to address this, whether it is some sort of ‘difference in conditions’ policy that sits above the property and cyber policies, or more collaboration between the property and cyber underwriters and brokers to come up with a more effective solution,” she said.
Levy admitted, however, that creating some kind of hybrid product would be very challenging for insurers. “Cyber and property are two very different coverages with different profitability standards and historical data sets. The most likely solution is an umbrella or difference in conditions policy rather than stretching either set of underwriters beyond their comfort zone,” she said.
Another major challenge is aggregation of risk, with tens of thousands of businesses potentially facing disruption if any of the leading cloud providers went down.
“What is the aggregated business interruption and property damage exposure of one or several of these facilities if they were attacked all at once or there was a large weather event?” asked Charron. “If a major facility is taken down it could have a dramatic impact on the insurance industry.”
When in Doubt, Sue
Cloud users may have another form of protection. Robert Parisi, Network Security and Privacy Practice leader at Marsh, who places E&O and professional liability (PL) risks for cloud service providers, believes providers are vulnerable to PL claims, even if interruption or loss of data was caused by a physical risk rather than negligence.
“I don’t think there are gaps in coverage. If a cloud provider is unable to provide their service, it is going to come back at them as a PL claim. The end user is not going to care one whit why the cloud provider wasn’t there when they needed them — they just know they have a contract and the provider didn’t honor it,” he said.
Accordingly, cloud providers have to ensure their E&O and PL policy wordings are airtight in their response to ‘act of God’ type risks or even deliberate physical sabotage and terrorism risks.
“From an end user’s perspective, the principal recovery vehicle is going to be that PL policy, so the cloud providers and their brokers need to look under the hood of their policies,” said Parisi. “The market has evolved and is getting better at providing solutions, and the coverage is fairly broad. It is up to the broker to be aware those solutions exist and stitch them together for [the cloud provider].”
Parisi said PL claims against cloud providers are common, particularly in the litigious United States where cloud users also have very high expectations — anything less than 24-hour service at optimal speed could result in a PL claim, particularly from users whose businesses rely on real-time data feeds, he said.
“Tech companies are regularly sued for failing to provide service or failing to render the service non-negligently. Tech is not perfect, and when it goes wrong, usually the first thing a client of a tech company is going to do is assume the tech provider must have done something wrong,” he said.
“Not only is the cloud provider going to be held to rendering the service and having the service functioning as intended, there is also an element of latency risk; clients want their service working now, on demand, and without any delays.”
In order for the cloud providers to ensure they get adequate coverage against such claims, they must demonstrate high levels of risk management including building redundancies into their systems so that if one facility is damaged, the data can be switched rapidly to another network or facility without being lost.
“One of the large tech companies runs an entirely parallel network right next to their production network so if anything happens they can switch their customers from the day-to-day network to the parallel redundant network in the blink of an eye,” said Parisi.
“That’s an extreme example – most providers don’t have a parallel network. But if they are going to guarantee 100 percent up-time they need to make sure they have the facilities that can do that — and if that means geographically separating their data centers then that is what must be done.”
When it comes to liability for data loss or service downtime, much hinges on the service level agreement between the two parties.
“This agreement defines what level of liability the provider assumes. In that contracting process the provider can say they will deliver their service but there are things outside of their control, and if those things prevent the service the user will have to live with that,” said Parisi. “That won’t always necessarily fly in the negotiation process — in which case the provider may put liquidated damages or limitations of liability clauses with pre-agreed settlements or caps on liability into the contract.”
Parisi added that one of the best things a cloud provider can do to limit their liability is to manage the expectations of the cloud user.
“The quickest way for someone to think the provider did something wrong is for the provider to overpromise,” he said, noting that startup cloud providers are most susceptible to this as they aggressively compete for business.
Ultimately, though, cloud users must take responsibility for their own data — particularly if it is critical to their business. “Cloud users should take it as incumbent upon them as part of their risk management policy to ensure they have their data backed up, and most of them probably do,” said Zurich’s Charron. “The rub is if they are creating new data all the time and there is value in the creation of this new data being generated. Identifying whether data is confidential or mission-critical can help the user understand how often they should back up their data.”
Parisi said cloud use should be treated with the same common sense as any other enterprise risk.
“If you’re relying solely on a third party for the sanctity and security of your data, you are probably making a lot of other mistakes in your business,” he said.