In This Issue:

• “Contractual Liability” Exclusion Applies Only To An Insured’s Assumption of Another’s Liability
• Illinois Court Of Appeals Rejects Insurer’s Rescission Claims Based On Allegedly Inadequate Disclosures
• Excess Insurer Not Entitled To New Trial In Case Where It Sought To Veto Reasonable Settlement
• Second Circuit Orders Travelers To Pay $510 Million To Asbestos Claimants

“Contractual Liability” Exclusion Applies Only To An Insured’s Assumption of Another’s Liability

Why it matters
The Michigan Court of Appeals joined the majority of courts nationwide in holding that a “contractual liability” exclusion applies solely to contracts involving the assumption of liability of a third party, and not the insured’s own potential liability stemming from performance of a contract. Importantly, the court found unpersuasive the insurer’s contention that, by failing to apply the contractual liability exclusion, the trial court had expanded the scope of the policy to include contract claims, when the policy was intended to be limited to potential tort liability.

Detailed Discussion
The University of Michigan contracted with Peaker Service to perform work on the University’s power plant. Not long after Peaker’s work was complete, the power plant began to experience problems, and the University sued Peaker.

Peaker sought coverage from its CGL insurer, Travelers Property Casualty Company, seeking defense and indemnity for the University’s claim. Travelers then filed a declaratory judgment action that it had no duty to defend or indemnify Peaker because its claim was excluded under the “contractual liability” exclusion.

Travelers’ exclusion contained standard-form language applicable to “‘bodily injury’ or ‘property damage’ for which the insured is obligated to pay damages by reason of the assumption of liability in a contract or agreement.” The policy did not define “assumption of liability.”

Travelers cited a portion of Peaker’s agreement with the University stating that, in the event the power plant was damaged, Peaker would be “responsible for the costs to return the property to ‘as was’ condition.” Travelers argued that, in this clause, Peaker “assumed” its own liability and therefore was not covered for damages arising from breach of the contract.

Peaker argued that the term “assumption of liability” is generally understood to connote situations in which an insured assumes the liability of a third party, such as an indemnity or hold harmless agreement, and that “assuming liability” is wholly distinct from assuming a duty to perform a contract in a certain manner. The Court of Appeals found that the commonly used definition of the term “assumption,” as well as the bulk of persuasive authority from other courts, favored Peaker’s position. Because Peaker did not contractually assume the liabilities of another party, the exclusion did not apply.

The court also found unpersuasive Travelers’ argument that, by failing to apply the contractual liability exclusion, the trial court had expanded the scope of the policy to include contract claims, when it was meant to be limited to potential tort liability. Although the University’s claim was styled as a breach of contract action, the court concluded that “the substance of the claim sounded in negligent performance of the underlying contract that could have given rise to either a tort or contract claim.”

To read the opinion in Travelers Property Casualty Co. of America v. Peaker Services, click here.

Illinois Court Of Appeals Rejects Insurer’s Rescission Claims Based On Allegedly Inadequate Disclosures

Why it matters
When applying for product recall coverage, a drug manufacturer’s disclosure of a newspaper article referencing potential risks associated with the manufacturer’s product was sufficient disclosure to avoid rescission of its policy, the Illinois Court of Appeals recently ruled. In affirming a judgment in favor of the insured, the court rejected the insurer’s position that the insured had lied in its applications. The court also held that an insurer seeking to rescind a policy for fraud or misrepresentation must do so promptly after learning of the alleged fraud or misrepresentation.

Detailed Discussion
In April 2000 various underwriters at Lloyd’s of London issued product recall insurance policies to Abbott Laboratories. In December 2000 Abbott announced that it was acquiring Knoll Pharmaceutical, whose products included various weight-loss products.

Pursuant to the recall policies’ terms, Abbott submitted applications to Lloyd’s related to additional premium necessary to cover the additional risks associated with the acquisition. Each of the applications contained a question regarding whether Abbott had any knowledge of any current situation, fact, or circumstance that might lead to a claim under the policies, to which Abbot answered “no.”

Abbott had signed the final insurance application, but not all of the Lloyd’s underwriters had agreed to the final terms of coverage, when The Wall Street Journal ran an article regarding the possibility that the Food and Drug Administration may pull the weight-loss drugs from the market. An Abbott representative advised Lloyd’s U.S.-based agent of the article’s existence, but did not forward a copy of the article to Lloyd’s at that time. Although various Lloyd’s underwriters initially voiced objections to the additional coverage, the parties eventually reached agreement as to the additional premium. Abbott paid the premium, and at the same time provided a copy of The Wall Street Journal article to the Lloyd’s underwriters.

A few months later Abbot recalled the weight-loss drug and tendered a claim to Lloyd’s under its policies. Lloyd’s responded with a complaint for rescission of the policies, alleging that Abbott lied on the application regarding regulatory scrutiny of the now recalled weight-loss-related medication.

A bench trial followed. The judge found that Abbott did not make a material misrepresentation in its application, and that the Lloyd’s underwriters had waived any claim of rescission. The court then entered an order that Lloyd’s was liable for $84.5 million.

Lloyd’s appealed, pointing to two alleged circumstances of fraud: Abbott’s answer of “no” when asked about knowledge of facts or circumstances that might lead to a claim, and that Abbott had deliberately withheld The Wall Street Journal article until after Lloyd’s had bound the additional recall coverage for Knoll. The Court of Appeals rejected these arguments, citing “ample evidence” to support the trial court’s conclusion.

Lloyd’s further argued that they had voiced their concerns immediately regarding the weight-loss medication’s status, had launched an investigation, and had even entered a tolling agreement to preserve their rights. The Court of Appeals, however, ruled that the Lloyd’s underwriters had moved too slowly.

“It is only when the magnitude of the [weight-loss medication] claim became apparent that the underwriters then renewed their year-old request for the Knoll due diligence documentation,” the court stated. “In the exercise of ordinary diligence, the underwriters could have ascertained the pertinent facts regarding what Abbott knew about [the medication]’s regulatory status, but instead, it did nothing.”

To read the opinion in Certain Underwriters at Lloyd’s, London v. Abbott Laboratories, click here.

Excess Insurer Not Entitled To New Trial In Case Where It Sought To Veto Reasonable Settlement

Why it matters
Policyholders too often are faced with the perilous scenario of having their insurers refuse to agree to reasonable settlements of underlying claims. In a recent decision, the U.S. District Court for the Southern District of California rejected one excess insurer’s motion for a new trial in a case in which the court previously held that the excess insurer had no right to arbitrarily veto a reasonable settlement of a false advertising claim against its insured. In so holding, the court rejected the excess insurer’s arguments regarding improper jury instructions and admission of improper testimony, and ultimately upheld the prior jury verdict against the insurer of $3.75 million.

Detailed Discussion
Ambu Inc. sued competitor LMA North America, alleging that LMA’s advertisements falsely implied Ambu’s products were unsafe or less reliable than LMA’s competing products. LMA settled the lawsuit for $4.75 million. LMA’s primary liability insurer paid its full policy limits of $1 million toward the settlement.

LMA then sought the remaining $3.75 million from its excess insurer, National Union. National Union refused to pay. LMA then filed suit in California federal district court, alleging breach of contract and bad faith. After a week-long trial, the jury found unanimously in LMA’s favor. Together with fees, costs, and prejudgment interest, the trial judge entered a final judgment of just over $6 million for LMA.

National Union then sought a new trial, arguing that the evidence at trial did not support the jury’s verdict. The court disagreed, denying National Union’s motion. “Viewing the evidence presented at trial in the light most favorable to plaintiff, and drawing all reasonable inferences in plaintiff’s favor, the court finds that ‘there [was] such relevant evidence as reasonable minds might accept as adequate to support the jury’s conclusion’ that plaintiff was entitled to prevail on its claim for breach of contract.”

The court further rejected National Union’s contention that the jury instruction applying a preponderance-of-the-evidence standard was improper, and that a higher standard should have been applied. The court noted that neither party had objected to the proposed jury instruction regarding burden of proof. Moreover, the court held, even if National Union had timely objected, “the error would have been harmless given the overwhelming evidence supporting each element of the claim, including that the amount of the settlement was reasonable and that National Union was afforded a reasonable amount of time to make a decision to accept the settlement or reject the settlement and assume the defense.” Moreover, the court held, jury instructions regarding the reasonableness of the settlement, the genuine dispute doctrine, consent to settlement, and negligence, mistake, bad judgment, and unclean hands all were accurate.

National Union further challenged testimony allowed at trial, including LMA’s expert opinion regarding the reasonableness of the settlement and comments from LMA’s corporate representative that he received a recommendation to accept the underlying settlement. The court rejected these challenges as well, holding that the testimony could have been dealt with through cross-examination.

Other trial issues, including LMA’s questioning of National Union’s corporate representative whether he had “rehearsed his testimony” with defense counsel and repeated disruptions to National Union’s liability expert’s testimony by sidebars, were dealt with correctly, either by being stricken from the record or through curative instructions, the court concluded.

To read the decision in Teleflex Medical Inc. v. National Union Fire Insurance Co., click here.

Second Circuit Orders Travelers To Pay $510 Million To Asbestos Claimants

Why it matters
Weighing in on a long-running dispute arising from the bankruptcy of Johns-Manville Corp., the Second Circuit Court of Appeals recently ordered several of the Travelers companies to pay up to $510 million directly to asbestos claimants. The case began when Travelers reached a settlement with certain claimants, but payment of the settlement was put on hold when another insurer objected. Nearly a decade later, Travelers refused to pay, arguing that certain conditions of the settlement had not been met as a result of the other insurer’s ongoing objections. But the appellate panel unanimously rejected Travelers’ “subjective hopes” as unsupported by the language of the settlement, ordering Travelers to pay the $445 million promised in the settlement deal, plus interest.

Detailed Discussion
Facing thousands of asbestos-related claims, Johns-Manville Corp. filed for Chapter 11 bankruptcy protection in 1982. In 1986 Travelers, which had been Manville’s primary insurer for many years, agreed to contribute roughly $80 million to a trust to compensate victims in exchange for a complete release of Manville’s asbestos-related liabilities.

Despite the settlement, thousands of asbestos plaintiffs sued Travelers directly in subsequent years. Many of the suits alleged wrongdoing against Travelers in its capacity as Manville’s insurer, including that Travelers fraudulently perpetuated a “state-of-the-art defense” and that Travelers “failed to disclose what it knew about asbestos hazards from its relationship with Manville.”

In 2004 a second settlement was reached that included the direct action plaintiffs, this time for $445 million. The settlement imposed three conditions for payment: a “Clarifying Order” had to be issued by the bankruptcy court barring additional claims against Travelers, the Clarifying Order had to become a final order from which no appeal could be taken, and at least 49,000 general releases of claims had to be delivered into escrow.

Third parties immediately filed objections to the settlement, including Chubb Indemnity Insurance Company. Chubb argued that the Order violated its due process rights because it had never been notified of the 1986 agreement, yet it could be bound by the broad terms of the Order. The bankruptcy court denied the objection and issued the Clarifying Order in 2004. Chubb appealed all the way to the U.S. Supreme Court, which concluded that the Clarifying Order was a proper exercise of the bankruptcy court’s jurisdiction. The Supreme Court did not, however, address which parties might be bound by the Order. On remand, the Second Circuit held that Chubb was not bound by either the 1986 orders or the Clarifying Order.

In 2010, three groups of plaintiffs involved in the 2004 settlement filed a motion to compel Travelers to pay the agreed-upon amounts. Travelers refused, arguing that the conditions of the Clarifying Order had not been satisfied because Chubb could still bring claims against it. The bankruptcy court granted the order to compel, but a federal district court judge reversed.

Reversing and reinstating the bankruptcy court’s order, the Second Circuit found that the conditions of payment were fully satisfied. Just because Chubb successfully challenged the Clarifying Order, the court held, Travelers was not off the hook. Even though Chubb might potentially bring a claim against Travelers, the integrity and breadth of the Clarifying Order remained in place.

“Travelers’ reading asks us to adopt an interpretation of the Clarifying Order that could not reasonably have been intended by the parties, whatever Travelers’ private hopes and dreams, and is not supported by the language of the agreements,” the court wrote. “The interpretation proposed by Travelers would have required the bankruptcy court either to (1) certify that all potential claimants – all entities and individuals on the planet, from now until the end of time – have received constitutionally sufficient notice of the 1986 orders and their relevant proceedings; or (2) bar all claimants whether or not they had constitutionally sufficient notice.”

Since both of these options were “well beyond the bankruptcy court’s power,” Travelers’ argument failed, the panel held. Put somewhat differently, Travelers proposed an interpretation incapable of ever being fulfilled, which would have rendered the deal a nullity from its inception.

Therefore the Clarifying Order met the first condition. The second was met because the Supreme Court’s decision was a final order. The remand of the case and subsequent Second Circuit decision – even the finding that Chubb was not bound by the 1986 orders – did not render the Clarifying Order any less final, the court held. “It would defy logic to hold that the Clarifying Order, as an extension of the 1986 orders, is not ‘final’ simply because Chubb did not receive constitutionally adequate notice of the 1986 proceedings,” the court opined.

As for the third condition, the court held, Travelers waived any challenge by failing to raise the issue before the bankruptcy court.

With all three conditions satisfied, the court reinstated the bankruptcy court’s order compelling Travelers to pay the promised $445 million, as well as statutorily prescribed interest, bringing the total payment to $510 million.

To read the decision in In re Johns Manville, click here.