In This Issue:

• South Carolina Court Holds That Absent Substantial Prejudice, Late Notice Does Not Bar Insurer’s Coverage Obligations
• “Arising Out of” Language Broad Enough to Link Coverage for Law Firm Fee Dispute to Professional Liability Policy Language
• Excess Insurer’s Consent to Settle Not Required for Claim That Did Not Reach Its Attachment Point
• Illinois Court Applies Its Well-Established Estoppel Doctrine to Insurer’s Defenses, Court Affirms Indemnification

South Carolina Court Holds That Absent Substantial Prejudice, Late Notice Does Not Bar Insurer’s Coverage Obligations

Why it matters
A federal court in South Carolina ruled that absent a showing by an insurer of substantial prejudice caused by the insured’s late notice, an insurer that breached its duty to defend will be liable for reasonable costs of defense, including pre-tender costs. The court reasoned that the duty to defend exists before notice is required, since it is triggered when the underlying claim was filed. If the alleged delay was not a factor in the decision not to defend, then it should not later be used by the insurer to refuse to pay any incurred costs. Further, the court held that because the insurer breached its duty to defend, the insurer lost its right to later control the defense and select defense counsel.

Detailed Discussion
Facing doctrinal differences, a group of churches broke away from the Episcopal Church in South Carolina (TEC-SC). However, the breakaway churches continued to use the same intellectual, real, and personal property they used prior to the split. In order to clarify ownership of the property rights, the breakaway churches filed a declaratory judgment action in state court.

TEC-SC’s insurer Church Insurance Company of Vermont (CIC-VT) denied coverage for the underlying litigation, contending that because the policy required prompt notice of a suit, such notice is a condition precedent to the duty to defend.

According to CIC-VT, allowing an insured that disregarded a policy’s notice provision to recover its pre-tender expenses would render meaningless contractual terms necessary to trigger the insurer’s performance under the policy. CIC-VT further asserted that because the policy provides that an “insured must not make payments or assume obligations or other costs except at the insured’s own cost,” the pre-tender costs were costs voluntarily assumed by the insured. The court disagreed.

The court determined that “an insurer’s duty to defend arises upon the filing of the underlying complaint, and late notice from the insured does not excuse the insurer from complying with its duty to defend except where the insurer can show substantial prejudice.”

If the delay in giving notice is not a factor in the insurer’s decision not to defend – if it would have declined the defense in any event based on its mistaken conclusion that there was no potential coverage – the insurer should not later be allowed to use the delay as a bar to reimbursing the insured for the reasonable expenses incurred in defending the covered claim, the court ruled.

Further, the court rejected CIC-VT’s position that breach of the duty to defend does not prevent the insurer from later selecting defense counsel and controlling the defense. “Plaintiff has hired counsel to put forth a vigorous defense in the Underlying Action and wishes to continue with its chosen counsel rather than change attorneys at a late stage in the litigation. Given the complex nature of the claims involved in the Underlying Action, it will suffer substantial prejudice if CIC-VT can take over control of Plaintiff’s defense more than a year following the initiation of the lawsuit.

To read the opinion in The Episcopal Church in South Carolina v. Church Insurance Company of Vermont, click here.

“Arising Out of” Language Broad Enough to Link Coverage for Law Firm Fee Dispute to Professional Liability Policy Language

Why it matters
Taking a broad interpretation of the phrase “arising out of the rendering of or failure to render Professional Legal Services,” a federal court in Texas held that a professional liability insurer was obligated to provide a defense to a law firm for a fee dispute. The insurer contended that the underlying fee dispute did not meet the policy’s definition of “Professional Legal Services.” Although the court recognized that billing and fee setting may not be “acts constituting acts arising out of professional services,” the dispute would not have come up “but for” the attorney-client relationship between the former client and the law firm. The court concluded that under Texas law, the phrase “arising out of” means that there is simply a causal connection or relation, though not necessarily direct or proximate causation. Therefore, despite being a fee dispute, because the claim had a “causal connection or relation” to the provision of professional legal services, a defense was owed.

Detailed Discussion
In the underlying action, the policyholder Shamoun & Norman law firm sued a former client for allegedly failing to pay the law firm certain performance bonuses. The former client counterclaimed, accusing the firm and its managing partner of attempting to extort $18 million from him through an unfair contingency fee.

Shamoun & Norman presented the claim to its professional liability insurer Ironshore Indemnity. The policy required Ironshore to defend and indemnify the law firm against claims “arising out of the rendering of or failure to render Professional Legal Services.”

Ironshore denied coverage, arguing that a fee dispute was not a “professional service.”

Ultimately, the underlying case went to trial, at which time the jury determined that neither the law firm nor the former client should recover anything. The law firm then brought suit against Ironshore to recoup its defense costs.

The Ironshore policy did not provide its own definition of “arising out of the rendering of or failure to render.” Therefore, the court stated, “if the claims against the plaintiffs had a ‘causal connection or relation’ to the provision of professional legal services, then Ironshore possessed a duty to defend.”

Although the court found that “[w]hile billing and fee setting may not be ‘acts constituting “professional services,”’ this does not answer whether they are acts ‘arising out of professional services,’” the court stated. In Texas, “arise out of” means “that there is simply a causal connection or relation, which is interpreted to mean that there is but for causation, though not necessarily direct or proximate causation.”

“In [the] original complaint, [the former client] alleged the plaintiffs ‘had a fiduciary duty to their client which they breached,’” the court stated. “But for the plaintiffs’ attorney-client relationship, there would be no claim for breach of fiduciary duty. Therefore, the claim has a ‘causal connection or relation’ to the plaintiffs’ provision of professional legal services.”

To read the opinion in Shamoun & Norman LLP v. Ironshore Indemnity, Inc., click here.

Excess Insurer’s Consent to Settle Not Required for Claim That Did Not Reach Its Attachment Point

Why it matters
A Michigan federal court held that an excess liability insurer was liable for a $7.6 million settlement, finding the insured did not have to obtain the insurer’s consent to settle where the settlement was entered into before the underlying insurance was exhausted. The insurer argued that a provision in its excess policy required that it be consulted on all settlements, but the insured contended that the provision applied only to settlements within the excess policy layer. Finding the excess policy was ambiguous as to whether the insured was required to obtain the excess insurer’s consent to settle, the court resolved the ambiguity in favor of the insured, ruling that the insurer’s consent would have been a meaningless gesture given that the settlement amount was nowhere near the attachment point for its policy.

Detailed Discussion
A manufacturer and marketer of medical supplies, Stryker Corporation purchased from Pfizer the assets of another company that made artificial knee joints. More than a decade later, Stryker began facing product liability lawsuits over the knee joints.

For insurance coverage, Stryker had a $15 million commercial liability policy issued by XL Insurance Company that included a $2 million self-insured retention. Excess insurer TIG Insurance Company’s attachment point was $17 million.

Stryker sued XL when the insurer refused to defend or indemnify the company for the product liability lawsuits. The insured funded its own defense and eventually settled the cases for more than $7.6 million. A court subsequently determined that XL was liable.

In the interim, Pfizer was facing similar litigation over the knee joints. Pfizer filed suit against Stryker for indemnification and a federal court in New York ruled that Stryker was liable to Pfizer for all losses relating to sales after Stryker’s purchase date. Stryker filed suit against XL and TIG for coverage in the Pfizer action, noting that the damages might exceed $18 million.

After a conference with all parties, XL paid Pfizer more than $17 million to settle Stryker’s liability, exhausting its policy limits. All that remained at issue was the original $7.6 million settlement.

TIG argued that it was not required to cover $7.6 million paid in settlements because Stryker failed to obtain TIG’s consent before entering into them.

TIG had argued that a provision in its excess insurance policy with Stryker required that it be consulted on all settlements, but Stryker argued that provision applied only to settlements within its policy layer.

The court found that the policy was ambiguous as to whether TIG’s policy would require Stryker to seek its consent to settlements that were below its policy layer. Noting that Michigan law routinely construes ambiguous language in an insurance policy against the insurer, the court found that Stryker should not be required to obtain TIG’s consent for the direct settlements because it settled the claims within the XL layer of insurance. Moreover, obtaining TIG’s consent would have been meaningless, the court concluded, because XL had already denied coverage at that time.

Further, the court reasoned that the purpose of the consent requirement – i.e., to give the insurer the opportunity to contest liability and to participate in settlement negotiations – would not have been met by requiring Stryker to seek TIG’s consent because TIG had no interest in involving itself in settlements that were within XL’s layer.

To read the opinion in Stryker Corporation v. XL Insurance Company, click here.

Illinois Court Applies Its Well-Established Estoppel Doctrine to Insurer’s Defenses, Court Affirms Indemnification

Why it matters
A recent opinion from the Illinois Appellate Court held that an insurer that failed to defend under a reservation of rights or file a declaratory judgment action was estopped to deny a duty to indemnify based upon an argument that the party seeking coverage did not qualify as an additional insured. The court held that Illinois law mandates that an insurer may not simply refuse to defend an insured, but must either defend the suit under a reservation of rights or seek a declaratory judgment that no coverage exists. The insurer chose neither of these options, the court stated, leaving the insurer estopped from raising policy defenses to coverage.

Detailed Discussion
Certain Underwriters at Lloyd’s, London (Underwriters) issued a commercial general liability policy to Toji Engineering, Ltd. (Toji).

311 Builders, Inc., a general contractor, hired Toji as a subcontractor on a construction project at property owned by 311 Lincolnway Properties, LLC (collectively with 311 Builders, Inc., the “311 Entities”).

Underwriters’ policy named the 311 Entities as additional insureds. Mt. Hawley Insurance Company (Mt. Hawley) issued separate commercial general liability coverage to the 311 Entities.

Following an accident at the site of the construction project, the underlying plaintiff sued the 311 Entities, Toji and others. The 311 Entities tendered the lawsuit to Underwriters for defense and indemnity. Underwriters denied the claim on the basis that the underlying complaint did not trigger additional insured coverage because it did not allege that the 311 Entities were vicariously liable for the acts or omissions of Toji.

Underwriters did not institute a declaratory judgment action. After Toji was dismissed from the underlying case, the 311 Entities asked Underwriters to reconsider its denial of coverage. Underwriters again denied coverage.

Mt. Hawley then paid $325,000 to settle the underlying claims against the 311 Entities and sought to recoup those funds from Underwriters in a declaratory judgment action.

While Underwriters agreed to pay defense costs, they continued to maintain that they had no indemnification obligation. Mt. Hawley argued, and the trial court held, that Underwriters was estopped from relying on its additional insured defense to indemnification as a result of its wrongful refusal to defend the 311 Entities.

The appellate court affirmed the trial court decision, rejecting Underwriters’ argument that its proposed defense should not be considered a “policy defense” and held that the defense was subject to the “well-established estoppel doctrine.”

“[T]he reason Underwriters is estopped from asserting policy defenses to coverage under the Toji policy is that it did not fulfill its duty to defend the 311 entities,” the court wrote. “In light of Underwriters’ wrongful conduct in this case, the doctrine of unclean hands precludes Underwriters from asserting its own equitable argument.”

To read the opinion in Mt. Hawley Insurance Company v. Certain Underwriters at Lloyd’s, London, click here.