Case 2:09-cv AB Document 45 Filed 09/28/10 Page 1 of 72 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA

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1 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 1 of 72 IN THE UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF PENNSYLVANIA RCM TECHNOLOGIES, INC., Plaintiff, Civil Action No AB v. ACE AMERICAN INSURANCE COMPANY, JURY TRIAL DEMANDED Defendant. RCM TECHNOLOGIES, INC. S MEMORANDUM IN REPLY TO ACE AMERICAN INSURANCE COMPANY S OPPOSITION (DKT. 36) TO RCM S MOTION FOR PARTIAL SUMMARY JUDGMENT (DKT. 35) AND IN OPPOSITION TO ACE S THREE MOTIONS FOR PARTIAL SUMMARY JUDGMENT (DKTS. 37, 40 & 44) Plaintiff, RCM Technologies, Inc. ( RCM ), submits this memorandum, its response to ACE American Insurance Company s ( ACE ) statements of facts 1 and its additional exhibits in reply to ACE s opposition (dkt. 36) to RCM s motion for partial summary judgment (dkt. 35) and in opposition to ACE s three motions for partial summary judgment (dkts. 37, 40 and 44). 2 1 ACE filed a separate statement of undisputed facts with each of its three motions. Although ACE has listed a total of 199 facts in its three briefs, there is a great deal of redundancy among them. RCM has assembled all of ACE s undisputed facts and RCM s responses into one document that also indicates which of the facts in ACE s briefs are repetitive or are modified between briefs. The document also includes RCM s statement of undisputed facts from its opening memorandum, and ACE s responses. (ACE disputed only four of the 40 material facts that RCM had listed.) This compendium of facts and responses is being filed separately from this memorandum. The Facts section below is a summary of what the evidence shows. 2 RCM obtained leave of Court to file a memorandum in excess of 50 pages to respond to ACE s 225 pages of briefing.

2 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 2 of 72 FACTS INTRODUCTION This case is an insurance coverage dispute between a software developer and its insurer resulting from the insurer's handling of the defense of a multi-million dollar professional liability lawsuit filed against the software developer by a dissatisfied customer. After agreeing to the appointment of defense counsel while purporting to reserve its rights to dispute coverage, the insurer virtually ignored the case for almost a year, made no meaningful effort to settle the case, and used its control over the settlement process to improperly pressure the insured to contribute to a settlement. When the insurer's efforts to coerce settlement funds from its policyholder failed, the insurer finally took steps to settle the case on the very eve of trial, with the insurer and insured agreeing to resolve their coverage dispute separately. This litigation followed, in which the policyholder seeks to hold the insurer liable for its obligation to cover the settled case and for damages resulting from the insurer's bad faith handling of the claim. THE PARTIES Plaintiff RCM Technologies, Inc. is a New Jersey based corporation engaged in the consulting and staffing business, including information technology consulting and project staffing. Its headquarters is in Pennsauken, New Jersey, and it has operations nationwide. Defendant ACE American Insurance Company is a Philadelphia based insurance company. ACE provided professional liability coverage to RCM pursuant to a digital technology and professional liability policy that included coverage for software development projects. 2

3 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 3 of 72 THE UNDERLYING LITIGATION This coverage dispute arose out of ACE's handling of a lawsuit brought against RCM by one of its customers, Topa Insurance Group ("Topa"). Topa had contracted with RCM for the development of a custom software system for use in Topa's insurance business (sometimes referred to as the "CAPRI" Project). In late 2007, the CAPRI project ran into some difficulties (Remer Deposition, Ex. KK hereto, p. 65), and in early 2008 Topa and RCM engaged in negotiations over how to get the project back on track. Although RCM believed the negotiations were proceeding well and that things would be resolved amicably, Topa was not satisfied and unexpectedly commenced litigation against RCM in California in June Pre-Litigation Negotiations Between Topa and RCM Extensive negotiations between Topa and RCM were triggered in early 2008 when Topa's outside counsel, Eric Sinrod, of the Duane Morris law firm, wrote to RCM's managers for the CAPRI project. Mr. Sinrod's February 8, 2008, letter (Ex. LL) was then forwarded by RCM's project team to RCM's corporate headquarters. Thereafter, RCM and Topa engaged in months of serious negotiations including detailed proposals on how to remedy the perceived deficiencies with the project. Neither Topa's lawyer, Mr. Sinrod, nor RCM's general outside counsel at White & Williams was directly involved in these negotiations. (Sinrod Dep., Ex MM, p ) The discussions and proposals concerned technical and project issues, not legal matters. RCM management viewed the letter from Mr. Sinrod and the ensuing negotiations with Topa as part of the ordinary give and take that occurs when the nature of a project changes or a project runs into difficulty. (Remer Dep., Ex. KK, p. 113; Miller Dep., Ex. NN, p. 135) RCM's management believed that these were contractual issues which were being worked out and did not think that litigation would ensue. (Remer Dep., Ex. KK, p. 65; Miller Dep., Ex. NN, p ) 3

4 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 4 of 72 Topa's commencement of litigation came as a surprise to RCM management. (Remer Dep., Ex. KK, p. 84, 96; Miller Dep.NN, p. 138) Because RCM management viewed Mr. Sinrod's letter as a means to get RCM to devote attention to the difficulties the project had encountered and not as a claim for damages or a prelude to litigation, it did not report the letter to ACE as an insured "claim". Only later, when RCM was served with Topa's complaint, did it view the situation to have become a covered claim and, at that point, reported the lawsuit promptly to ACE. RCM Is Sued By Topa and Tenders the Case to ACE Topa filed suit in California against RCM on June 11, Upon being served with the Topa complaint, RCM tendered defense of the suit to ACE. (Ex. OO) RCM was concerned that appropriate counsel be in place promptly because Topa was pressing the litigation forward, so RCM's outside general counsel at the Philadelphia law firm of White & Williams identified a California defense firm -- Murchison & Cumming -- which it believed would be an appropriate firm to defend the case. A White & Williams lawyer contacted the ACE claims adjuster who had acknowledged receipt of the complaint and asked if the Murchison firm could be designated as the defense counsel. The ACE claims adjuster agreed. (Mooney Dep., Ex. PP, p. 36, 34-35) Thereafter, RCM understood that ACE was undertaking the defense of the case, having authorized the engagement of the Murchison firm as defense counsel. RCM understood that its only responsibilities were to pay the first $250,000 of defense costs pursuant to the insurance policy's retention provision and to cooperate with the Murchison firm in discovery and other aspects of the case. (Miller Dep., Ex. NN, p. 198, 202) No one at RCM actively managed the defense of the Topa case because RCM's management understood that it was ACE's responsibility 4

5 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 5 of 72 to do so. 3 (Miller Dep., Ex. NN, p ) There was no discussion at RCM about control over the defense or about selecting counsel to act for RCM. (Miller Dep., Ex. NN, p. 182). RCM did not separately retain the Murchison firm; RCM understood the Murchison firm to have been retained by ACE, with only the payment of the first $250,000 of the firm's bills being the responsibility of RCM. (Miller Dep., Ex. NN, p , ). RCM understood that Topa was seeking several million dollars in damages, and realized that the litigation was going to be complex and extensive. In view of the insurance policy's $5 million limit and $250,000 self-insured retention, RCM's management concluded that RCM would inevitably have to pay the $250,000 deductible and that ACE would be responsible for the remaining expense of defending and settling the suit. (Miller Dep., Ex. NN, p. 202) That is, given the monetary parameters of the policy, the financial risk of the law suit was ACE's. ACE's Initial Inaction Upon receiving the Topa complaint in June 2008, ACE assigned the claim to one of its claims adjusters, Matthew Lange. The case was originally slated to be assigned by Mr. Lange to one of ACE's panel defense firms, Lewis Brisbois (Ex. QQ). Mr. Lange's initial acknowledgement letter to RCM's outside general counsel, Peter Mooney, Esquire, asked Mr. Mooney to call to discuss the appointment of defense counsel if it were time critical. When Mr. Mooney called, Lange agreed to his suggestion that the Murchison firm be designated the defense counsel. (Exs. RR, SS; Mooney Dep., Ex. PP, p , 26; Lange Dep., Ex. TT, p ). Although ACE's practice was to provide its policyholder with a statement of ACE's coverage position within 30 days (Lange Dep., Ex. TT, p. 26, 184), Lange did not do so until 3 The ACE Policy contained a typical defense clause obligating ACE to defend any potentially covered claim. (Ex. WW, IX(A)) 5

6 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 6 of 72 September 12, 2008, nearly three months after receiving the complaint, when he sent a letter to RCM which identified a few boilerplate coverage issues without any analysis of them or application of the terms of the policy to the specific circumstances of the Topa case. (Ex. UU) Mr. Lange's September 12th letter purported to reserve the right to disclaim coverage in the future in the event any of the listed exclusions were found applicable, but nothing in the letter gave any indication that ACE was not presently actively engaged in managing the defense of the lawsuit pursuant to the defense obligation provision of the insurance policy. Nor did the September 12th letter suggest that ACE was going to be handling the claim any differently because the defense firm was the Murchison & Cumming firm suggested by RCM rather than some other firm that ACE regularly hires. Despite the fact that ACE had led its policyholder to believe that ACE was assuming its contractual defense obligation, in fact, from the outset ACE took no steps to actively manage the litigation. ACE's claims adjuster, Mr. Lange, did not ask the Murchison firm about the status of the case, he did not ask the Murchison firm about its litigation plan, he did not seek any information from the Murchison firm to enable ACE to evaluate the case for settlement. Lange took no steps to evaluate the case for settlement himself or to develop a strategy for settling or defending it. 4 (Lange Dep., Ex. TT, 84-87). When Mr. Lange did not receive periodic written status reports from the Murchison firm (as called for in the case handling Guidelines which ACE provided), Lange was supposed to follow up and request them. (Levine Dep., Ex. ZZ, p ). Mr. Lange's supervisor explained that Lange should have reached out to defense counsel to find 4 Although Lange received detailed monthly bills from the Murchison firm showing the firm's activities (Lange Dep., Ex. TT, p. 78), he never asked for any additional information nor did he actively provide any input. 6

7 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 7 of 72 out what was going on in the case. (Sorkin Dep., Ex. AAA, p. 82). Instead, Lange did nothing. The only step of substance the Mr. Lange ever took was to send RCM the boilerplate reservation of rights letter on September 12th. 5 Mr. Lange basically ignored the case for almost a year. In his deposition in this case, when pressed to explain his inaction despite the clear terms of the policy obligating ACE to undertake the defense of the claim, Mr. Lange proffered the startling view that ACE had no defense obligation during the entire ten months of his inattention because RCM had not yet paid the full amount of its $250,000 retention. (Lange Dep., Ex. TT, p ). This position that ACE did not have a duty to defend RCM from the very outset -- was never communicated to RCM until ACE filed its answer to this lawsuit. During the time at issue, RCM had continued to believe, quite reasonably, that its insurer was looking after its interests. Mr. Lange's position -- that "ACE's duty to defend RCM did not commence until they had satisfied [their] retention... (Lange Dep., Ex. TT, p. 89) -- was also at odds with his usual practice. Mr. Lange could not recall any other case at ACE where he or any other claims person refrained from actively managing litigation because a self-insured retention had not been satisfied. (Lange Dep., Ex. TT, p. 152) Lange's position 6 was later disavowed at deposition by his superior at ACE, the vicepresident for claims. (Sorkin Dep., Ex. AAA, p. 98). 5 Interestingly, Mr. Lange claims he communicated the list of potential coverage issues to Mr. Mooney in their July telephone call, but he could not explain why he then waited two additional months to set them down on paper. According to Mr. Lange's supervisor, Lange's reservation of rights letters usually went out more quickly. (Sorkin Dep., Ex. AAA, p. 73) 6 Mr. Lange's "no duty" assertion was even at odds with the very few documents that he generated in this case. Mr. Lange's September 12th letter to RCM certainly appeared to confirm that ACE had assumed the duty to defend (See Lange Dep., Ex. TT, p ). 7

8 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 8 of 72 At some point in early 2009, Lange transferred the case to another ACE claims adjuster in New York who did no work on the case for some unspecified period of time and then transferred it back to Lange. (Levine Dep., Ex. ZZ, p ) Finally, Lange transferred responsibility for the case to yet another ACE claims adjuster, Inna Kogan, in April 2009 (Lange Dep., Ex. TT, p. 80). During the entire time that he was assigned the case for ACE, Mr. Lange did not do anything to oversee it. (Lange Dep., Ex. TT, p. 82) In particular, Mr. Lange took no steps towards evaluating the case for settlement and justified his inaction on that important front with the assertion that he had no responsibility to take any settlement initiative; if the insured wanted his input about settlement, the insured should have contacted him. (Lange Dep., Ex. TT, p ). Lange's conduct evidently was guided by the goal of protecting ACE dollars, not seeing to it that its policyholder had a good defense regardless of whose money was at risk. Lange conceded that had he realized that the likely exposure in the Topa case would be well over $1 million (most of which would come from ACE's pockets), he might have taken a more active role early on. (Lange Dep., Ex. TT, p. 101). ACE Finally Pays Attention to the Topa Litigation In April 2009, ACE finally woke up to the need to deal with Topa lawsuit. At about that time, Lange transferred the responsibility for the Topa suit to Inna Kogan, a very junior claims adjuster in New York. Ms. Kogan was a 2005 law school graduate who had joined ACE just a few months earlier after working at a large firm where she had no exposure to insurance coverage. (Kogan Dep., Ex. EEE, p ). She received no formal training in insurance coverage when she started working at ACE but relied on her supervisor to explain basic concepts such as "what is a deductible" and "what is a claim." (Kogan Dep., Ex. EEE, p. 23). She was initially given "simple matters where the exposure for ACE was not very likely." (Kogan Dep., 8

9 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 9 of 72 Ex. EEE, p. 23) Except, of course, the Topa claim. Her usual level of authority was $25,000. (Kogan Dep., Ex. EEE, p. 25) When Ms. Kogan received the Topa claim file, it contained only a few documents and a single file note of Lange's. Ms. Kogan contacted Lange for more information and documents but he could not provide any. (Kogan Dep., Ex. EEE, p ). Kogan then asked the Murchison firm for a detailed status report and was promptly provided with one. (Ex. FFF) Kogan quickly realized that the claim posed a multi-million dollar exposure and that RCM would almost certainly be found liable, 7 as set forth in her internal memoranda: "There is no chance that RCM will be successful at trial and therefore it is crucial to settle this matter." (Ex. GGG at p ) Nevertheless, Kogan did not actively formulate a plan to attempt to settle the case. Instead, ACE embarked on a course of conduct designed to force RCM to contribute substantially toward a settlement. Ms. Kogan did not prepare an updated coverage letter to spell out in detail to RCM what exclusions or coverage defenses ACE believed would justify RCM contributing to a settlement, nor did she tell RCM how much money ACE was willing to offer to Topa in settlement negotiations. Ms. Kogan recommended that ACE set a reserve on the case in the amount of $600,000, which was simply the amount of projected attorneys fees. This reserve was approved by her superiors at ACE. (Ex. BBB; Levine Dep., Ex. ZZ, p ) There is no question that after Ms. Kogan took over as claims adjuster, ACE actively controlled the litigation. For example, Ms. Kogan directed that the Murchison firm not take any action to evaluate damages until Blue Ally was added as a defendant and until RCM had 7 The Murchison firm's review of the documentation of the CAPRI project revealed numerous problems, many attributable to Blue Ally, a subcontractor used by RCM on the project, and also various documents evidencing RCM's knowledge of the problems, some written in terms that would make it virtually impossible for RCM to avoid liability. 9

10 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 10 of 72 informed ACE of how much it would contribute towards settlement. 8 (Ex. HHH at p ). From time to time, ACE requested the Murchison firm to provide supplemental analysis of the case, which it promptly provided. (Ex.III). Ms. Kogan requested the Murchison firm to provide detailed budgetary estimates, which it did. (Id. at ACE ) ACE viewed itself as having the right to authorize expert costs (Ex. KKK). For example, the Murchison firm sought authority from Ms. Kogan 9 to retain a jury consultant (Ex. LLL). ACE Uses Its Control Over the Settlement Process to Pressure RCM to Contribute to Any Settlement as A Condition of ACE Making a Serious Attempt to Settle ACE's position was that the case could not be settled without a contribution from someone other than ACE. (Levine Dep., Ex. ZZ, p. 151). Ms. Kogan's dealings with RCM reflected ACE's strategy to pressure RCM to contribute. In her first telephone call to Mr. Miller of RCM on June 10, 2009, Ms. Kogan took the position that the case needed to be settled, but that ACE would not settle it without a significant contribution from RCM. (Miller Dep., Ex. NN, p. 256, 259, ) Kogan subsequently denied insisting that RCM contribute towards settlement, claiming instead that she was merely giving Mr. Miller "examples on contribution" and saying only that "he should seriously consider making a contribution toward settlement." (Kogan Dep., Ex. EEE, p ; 140). However, ACE s subsequent actions demonstrated that ACE was not 8 Thus, it seems that the directions ACE gave to defense counsel were intended not always to further the defense of the claim against RCM but were designed to improve ACE's leverage against its insured in the battle over settling the Topa case. 9 Although Ms. Kogan asserted that the firm did not need her "authority" to do so, she said that was equally true of any panel firm ACE might retain to defend a covered claim. (Kogan Dep., Ex. EEE, p. 267). Ms. Kogan's passive view of what control she could exercise, whether in a case defended by panel counsel or by independent counsel, raises the question of what ACE actually understood was its obligation beyond merely signing checks. It was plainly at odds with the ACE Guidelines that ACE provided to the Murchison firm at the outset of the case (Ex. MMM, p. 5-6). 10

11 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 11 of 72 willing to make an independent effort to settle the case but instead was conditioning its settlement efforts on a substantial contribution from RCM. For example, despite RCM's repeated requests that ACE inform RCM of how much ACE would pay to settle the case, ACE repeatedly responded in terms of its "share" of the settlement, suggesting variously that the costs of settlement with Topa be split or between ACE and RCM. Until the very eve of trial, ACE refused to make any serious settlement proposal to Topa unless RCM would agree to pay a substantial portion. Upon realizing that ACE might not be acting to protect RCM's interests, RCM engaged coverage counsel, William Herman, Esquire. When Mr. Herman contacted Ms. Kogan, she informed him that ACE believed some of the pending claims against RCM were covered and some were not. (Herman Dep., Ex. NNN, p ). In a telephone call, she took the position that the claim for lost business revenue was covered (Herman Dep., Ex. NNN, p ), but despite repeated prodding, ACE never updated Mr. Lange's September 12, 2008 letter to provide RCM with a clear and comprehensive coverage position. ACE also rejected Mr. Herman's request that it take immediate steps to try to settle the Topa case which, by then, ACE acknowledged had to be settled. RCM repeatedly resisted ACE's efforts to condition meaningful settlement efforts on RCM's surrender of its coverage position that the entire claim was covered, but instead repeatedly urged ACE to settle with Topa, with RCM and ACE agreeing to resolve their coverage differences afterwards. ACE refused and continued to condition its settlement efforts on RCM's acceptance of a substantial share of the cost. ACE was finally forced to address the issue of settlement by the California court's requirement that an ACE representative attend a mandatory settlement conference in the Topa case on July 8, Initially, ACE was not planning to be at the conference and did not provide 11

12 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 12 of 72 defense counsel from the Murchison firm with any authority or even guidance on settlement. (Ex. OOO) Only when ACE was advised by defense counsel that California law required it to attend the settlement conference did ACE agree to send a representative. However, instead of Ms. Kogan or some other ACE claims adjuster who could participate in a meaningful effort at settlement attending, ACE chose to send its coverage counsel, John Lee, Esquire, of the law firm Wilson, Elser, Moskowitz, Edelman & Dicker, LLP in Los Angeles, whose role was to fend off RCM's insistence that ACE make a good faith effort to settle the case. ACE understood that the case could be settled within policy limits, but also knew there was a danger of an excess verdict. (Sorkin Dep., Ex. AAA, p. 133). On June 5, 2009, Ms. Kogan quantified the likely exposure at between $2.3 million and $4.5 million. (Ex. GGG). She also concluded that the case was a loser for RCM and had to be settled. (Id.; Ex. PPP at p ). However, instead of developing a strategy for ACE to settle the case, she took the position that others should bear the financial burden of doing so, with ACE merely contributing defense costs. ("The estimated settlement amount will depend on the outcome of the motion for summary adjudication, the amount the Insured and Blue Ally are willing to contribute toward settlement, and the litigation budget") (Ex. GGG). ACE Drags Its Feet on Settling the Case While Escalating the Pressure on RCM o Compromise on Coverage ACE took no steps to settle the case during June, blaming the delay on the pendency of motions addressed to the amount of damages (Kogan Dep., Ex. EEE, p ), despite the fact that Ms. Kogan understood that even if the motions went well, the likely damages at trial would be in excess of $2 million. (Ex. GGG, p ). Once RCM retained coverage counsel, 12

13 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 13 of 72 ACE had its coverage lawyer, John Lee, Esquire of the Wilson Elser firm, assume the role of primary contact person with RCM. Mr. Lee was even less forthcoming than Ms. Kogan in communicating ACE's settlement strategy or its coverage positions. Mr. Lee's recollection of his role was remarkably deficient: he could recall virtually no details of his conversations with RCM's coverage counsel during the crucial weeks after the July 8, 2009 settlement conference and leading up to the August 24, 2009 trial date. (Lee. Dep., Ex. RRR, p , 93). He also could not remember anything that ACE did to try to settle the case during the month following the unsuccessful settlement conference (Lee Dep., Ex. RRR, 105), despite the fact that RCM's counsel was pressing ACE to take action. (Lee Dep., Ex. RRR, p. 111). Prior to the settlement conference, RCM made the eminently reasonable request that ACE share its strategy and let RCM know in advance what it was prepared to offer at the conference. 10 Such information was particularly important to RCM inasmuch as ACE was repeatedly insisting, in one form or another, that RCM "get out its checkbook" and RCM needed to know how much of check ACE was willing to write and how much of a check RCM was being asked to write so that RCM could evaluate how to proceed. (Ex. SSS, p. 4) Instead, ACE stonewalled its policyholder and refused to tell RCM's coverage counsel what position it was going to take at the conference. (Lee Dep., p. 41). "You'll find out tomorrow," was all that ACE's counsel would say to RCM's counsel the day before the conference. (Ex. SSS, p. 4) At the settlement conference, Judge Owen Kwong informed ACE's representative that he believed the case could be settled in the $1 million to $2 million range. (Ex. HHH, p ). 10 ACE well understood that it was important to know what contributions others would make towards settlement, seeking that information from Blue Ally and from RCM. (Dep. Ex. 1 at ACE 09154). 13

14 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 14 of 72 According to the Murchison attorneys, "Judge Kwong pressed Mr. Lee for a settlement offer, but none was made by Mr. Lee on behalf of ACE." (Ex. TTT, p. 2). Instead of using the settlement conference in the Topa case as an opportunity to protect its policyholder's interests by trying to resolve the case, ACE used it as a platform for trying to extract concessions from RCM on coverage issues. 11 Although ACE's coverage counsel, John Lee, did not make any offer to settle the Topa case at the settlement conference, he used the conference to advance his arguments regarding coverage and to push for RCM to shoulder 60% of any ultimate settlement. (Ex. UUU) Inasmuch as ACE made no settlement offer at the conference, Topa did not move down from its initial $4.5 million demand. (Id). ACE knew the case was a loser, knew it should be settled, yet continued to drag its heels on trying to settle with Topa while escalating the pressure on RCM to contribute toward a settlement. RCM clearly and repeatedly communicated its position to ACE: that ACE should settle the case within policy limits and then ACE and RCM could resolve any coverage issues without the pressure of the looming trial date and the prospect of a much higher adverse verdict. (Ex. SSS, p..6-7) Instead, ACE continued to use its control over the settlement process (and the resulting threat of an adverse jury verdict) as a means to pressure RCM to give in on its settlement position. The inner workings of ACE's claims department show that its objective was first and foremost to minimize the cost to ACE and only secondarily to protect RCM's interest. For example, in the midst of the 11th hour negotiations, rather than merely consider what it would 11 To be clear, the July 8 conference in Los Angeles was a proceeding in the Topa litigation held to address settlement of that litigation. It was completely separate from an August 18th mediation at JAMS in New York with David Geronemus that involved only RCM and ACE and was addressed to the coverage dispute. 14

15 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 15 of 72 take to settle the case, ACE was equally concerned with how much it might ultimately be able to recover in subrogation from Blue Ally. (Ex. HHH, p ) Similarly, in deciding on how much to consider authorizing for settlement, ACE's primary consideration appeared to be its bottom line, not what it would actually cost to settle the case and protect its policyholder. When the Murchison firm told ACE that it estimated that defense costs going forward, through trial, would total $600,000 (Ex. HHH), ACE decided that was the most it would offer in settlement. (Kogan Dep., Ex. EEE, p ) ACE Inexplicably Refused To Inform RCM of ACE's Coverage Position When it became evident that ACE was resisting making any substantial effort to settle the case, RCM's coverage counsel repeatedly demanded that ACE explain why. (Ex. VVV, p. 6; Ex SSS, p. 8; Ex. OOO, p ); Kogan Dep., Ex. EEE, p ). Although ACE knew it was obliged to provide its insured with a prompt, clear and updated statement of ACE's coverage position, ACE failed to do so despite repeated requests from RCM's counsel. (Lee Dep., Ex. RRR, p. 75, 81-81). After several letters went unanswered, RCM's coverage counsel ed Ms Kogan: "ACE's refusal either to respond to the June 26th letter or to tell its insured what it expects from it, but rather to withhold that information in order to maximize the pressure on its insured at the mediation is extreme bad faith." (Ex. WWW). Yet the stonewalling continued. ACE's coverage counsel, John Lee, Esquire, several times brushed off questions from RCM's coverage counsel with a promise to provide a comprehensive coverage position "shortly." (Ex. XXX). He never did so and when questioned on why not, could not offer a single excuse. (Lee Dep., Ex. RRR, p ) Although the practice at ACE was to issue an amended reservation of rights letter when new circumstances or issues came to light (Lange Dep., Ex. TT, p ), ACE never did so in this case. 15

16 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 16 of 72 ACE Finally Settles the Case on The Eve Of Trial. With the August 24th trial date fast approaching and RCM resolutely resisting ACE's pressure, ACE finally took steps to settle the case. ACE understood that it would cost $1 to $2 million to settle. Judge Kwong had opined as much as had the Murchison attorney directly responsible for the defense. In late July ACE was informed that Topa had made a settlement demand of $2.5 million. (Ex. HHH, p ). With trial only a few weeks away, ACE nonetheless waited until August 7th to make a counterproposal and then only offered $150,000, which it had been told by the Murchison firm would not be viewed by Topa as a serious offer. ACE never explained its rationale for such a low offer. By that time, it had concluded that RCM was sure to be found liable, that the case had to be settled, and that damages could exceed $4 million. Predictably, Topa rejected the offer and increased its demand to $2.7 million to signal its view that the $150,000 offer was a waste of time. (Ex. CCC) Topa informally told the Murchison attorney defending the case that the settlement amount had to be at least $2 million. An August 18th mediation between ACE and RCM failed to resolve their coverage dispute. ACE then offered Topa $1 million and Topa countered at $2.45 million and reiterated informally to the Murchison attorney that the settlement amount had to be at least $2 million. (Ex. HHH, p ) Having by then lost any opportunity to settle the case for less than $2 million, ACE finally did what RCM had been asking it to do all along: it agreed to settle the case with Topa, with both 16

17 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 17 of 72 ACE and RCM reserving their positions on coverage. 12 A settlement was negotiated with Topa in the amount of $2 million, of which ACE paid $1 million up front with the other $1 million to be paid later, with interest. ACE and RCM separately agreed that they would resolve their coverage dispute after the Topa case was resolved. The Topa settlement was finally signed in September 2009, and this coverage action followed. ACE Manufactured the "Cumis Counsel" Excuse to Justify Its Inaction A central aspect of ACE's excuse for its conduct is its assertion that the Murchison firm was "Cumis counsel," 13 i.e., independent counsel appointed under Cal. Civ.Code 2860 at the demand of the policyholder because of potential conflict on coverage issues. RCM's outside counsel, Peter Mooney, Esquire, was the person who contacted Mr. Lange on behalf of RCM, and Mooney never discussed Cumis counsel with Mr. Lange. (Mooney Dep., Ex. PP, p ). His suggestion of the Murchison firm was just that a suggestion, not a demand under California law or otherwise. ACE's paper trail of references to a purported "Cumis" demand is suspicious in the extreme. First and foremost is a file note dated September 12, 2008, authored by Matthew Lange, purporting to memorialize his telephone conversation with Peter Mooney (of White & Williams) in which Lange claims that Mooney made a "cumis demand" [sic] and Lange assented to using the Murchison firm. (Ex. HHH, p ). It is clear that this conversation could not have occurred on or around September 12, 2008, because the Murchison firm was engaged in 12 In part, this may have been driven by ACE's concern that if the Topa case were allowed to proceed to trial, ACE might be liable for the entire verdict, even as to claims which it asserted might not be covered. (Ex. VV, p ) 13 San Diego Navy Credit Union v. Cumis Ins. Society, Inc., 162 Cal.App.3d 358 (1984). 17

18 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 18 of 72 early July To explain this evident fabrication, Lange claimed in his deposition that the file note was made months after the fact (Lange Dep., Ex, TT, p ) notwithstanding that every other file note in the case appears to be contemporaneous (Ex. HHH), and that ACE employees were instructed to keep careful notes of important contacts ("if you didn't put it in the note, it is like it didn't happen," Kogan Dep., Ex. EEE, p ). Furthermore, the conversation recited in the September 12th file note refers to the "numerous exclusions I would be reserving" which was an obvious reference to the September 12th letter that Lange sent to Mooney. The explanation did not fit with the facts. 14 Ms. Kogan's memoranda, also, were edited to insert references to "Cumis counsel" where none had existed in prior versions. (Compare Ex. PPP with Ex. GGG; Kogan Dep., Ex. EEE, ). Despite all of the suspicious internal ACE documents labeling the Murchison firm as "Cumis counsel," Mr. Lange did not once write to either RCM or to the Murchison firm to advise them of this view. (Seitz Dep., Ex. XX, p ) Mr. Mooney confirmed that he and Lange did not discuss coverage in their July conversation. (Mooney Dep., Ex. PP, p. 22)] And at his deposition, Lange retreated from his file note and conceded that Mr. Mooney may not have demanded "Cumis counsel" in their phone call, contrary to what he had written in the ACE internal document. (Lange Dep., Ex.TT, p , 194). Lange's new explanation for his inaction was that he "deferred" management of the case to RCM's outside counsel, although he conceded that he did not say anything to that effect to RCM's 14 Indeed, as Mr. Lange reconstructed the events at his deposition, he had in hand at the time of his early July conversation with Mr. Mooney all of the information he needed for the reservation of rights letter and asserted that shortly after the conversation he began drafting it. (Lange Dep., Ex. TT, p. 76). He could not explain why it took over two months to complete that routine task. (Lange Dep., Ex. TT, 112; 185) 18

19 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 19 of 72 outside counsel (Lange Dep., Ex. TT, p ) and could not explain how he could have deferred a case to someone without alerting that person. (Lange Dep., Ex. TT, p. 135). Nor did ACE treat the Murchison firm as Cumis counsel. ACE's coverage counsel, John Lee, claimed that he viewed the Murchison firm as Cumis counsel, although he refused to explain why he believed that (Lee Dep., Ex. RRRR, p.32). He apparently never discussed with anyone at the Murchison firm his view that they were Cumis counsel (Lee Dep., Ex. RRR, p. 34), and his actions were inconsistent with the Murchison firm being Cumis counsel. For example, in the run-up to the July 8th settlement conference, Mr. Lee focused his efforts not on formulating a way to settle the case with Topa but with obtaining information from the Murchison attorneys about the strength of the claims that Mr. Lee deemed to be uncovered, the fraud and negligent misrepresentation claims. (Ex. AAAA). Thus, far from treating the Murchison firm as "Cumis counsel" from whom the insurer should not seek information bearing on its coverage defenses, ACE's counsel did not refrain from discussing any subject with the Murchison lawyers. (Lee Dep., Ex. RRR, p ) Similarly, Ms. Kogan acknowledged that there was no topic about the underlying litigation that the Murchison firm declined to discuss with her or that she refrained from questioning them about, including issues such as fraud that were cited as grounds for denying coverage. (Kogan Dep., Ex. EEE, p ). Even had the Murchison firm been Cumis counsel, that would not have justified ACE's inaction on the settlement front. Ms. Kogan' supervisor acknowledged that when ACE has the duty to defend, it has the ability to control settlement, "[t]o analyze and steer the file towards a cost effective resolution for the insured." (Levine Dep., Ex. ZZ, p ). ACE viewed its duty to pursue settlement as the same regardless of whether the case was being handled by panel counsel or "Cumis counsel". (Levine Dep., Ex. ZZ, p. 116). As Ms. Kogan's supervisor 19

20 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 20 of 72 described the process, trial counsel should be actively involved in the settlement conference and should be informed by ACE of how much monetary authority ACE is extending to settle the case. (Levine Dep., Ex. ZZ, p. 127). He could not offer any reason why RCM and its coverage counsel would not be informed of ACE's settlement strategy and the coverage rationale which guided it. (Levine Dep., Ex. ZZ, p ) In this case, however, ACE kept both its policyholder and trial counsel at arms length and in the dark, conduct that would have been improper even had the Murchison firm's status as Cumis counsel been fact, not fiction. ARGUMENT I. NEW JERSEY LAW DOES NOT EXCUSE ACE FROM ITS VIOLATION OF LONG-STANDING REQUIREMENTS THAT AN INSURER MUST INFORM ITS INSURED THAT IT CAN REJECT A DEFENSE OFFERED UNDER A RESERVATION OF RIGHTS IF THAT RESERVATION IS TO BE EFFECTIVE. In its opening memorandum, RCM showed that ever since the decision in Merchants Indem. Corp. v. Eggleston, 179 A.2d 505, 511 (N.J. 1962), New Jersey courts have held that an insurer offering to defend under a reservation of rights must expressly tell its insured that it does not have to accept the conditional offer to defend. 15 When an insurer does not abide by this rule, its attempted reservation of rights is ineffective, [p]rejudice to the insured [is] assumed because the course cannot be rerun so as to determine whether the insured would in fact have fared 15 RCM Technologies, Inc. s Memorandum in Support of its Motion for Partial Summary Judgment. ( RCM Memo ), at

21 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 21 of 72 better by itself (Sneed v. Concord Ins. Co., 237 A.2d 289, 296 (N.J. Super. App. Div. 1967)), and the insurer is barred from disputing liability, even for claims that are not covered. 16 In opposing RCM s motion for partial summary judgment, ACE contends that there may be only a rebuttal [sic] presumption of prejudice when the insurer must disprove in order to overcome the bar of estoppel. (ACE American Insurance Company s Opposition to RCM Technologies Inc. s Motion for Partial Summary Judgment ( ACE Opp. Memo ), at 25, quoting Griggs v. Bertram, 443 A.2d 163, 170 n. 3 (N.J. 1982)). But ACE sweeps too broadly. Actually, here is what the New Jersey Supreme Court gave as its example of a possible exception to conclusive prejudice: a short delay before the insurer discloses its intentions regarding coverage Id. Accordingly, New Jersey courts have, in fact, carved out a single exception to Merchants conclusive prejudice rule -- when an insurer participates in the underlying litigation only briefly. Sussex Mut. Ins. Co. v. Hala Cleaners, Inc., 380 A.2d 693 (N.J. 1977), upon which ACE relies heavily, is a case in point. There, the insurer notified the insured that it would file an answer without prejudice to our rights to determine the coverage question and the necessity for us to defend the action (id., at 696), answered the complaint, promptly instituted a declaratory judgment action over coverage, and quickly obtained a stay of the underlying lawsuit. Id., at 694, 696. In reversing the Appellate Division s estoppel decision, the New Jersey Supreme Court held that the insurer s action in filing an answer on [the insured s] behalf and obtaining a stay amounted to no more than what the trial judge called it: maintenance of the status quo of the 16 RCM Memo, at

22 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 22 of 72 [underlying] suit pending an adjudication of the coverage issue. Id., at 697. The Supreme Court stated: [U]nder the circumstances of this case, the Appellate Division fell into error. We emphasize under the circumstances of this case because we have no intention of disturbing the rule restated in Merchants and explicitly acknowledged in this jurisdiction for almost fifty years.... Id., at 697. (Emphasis added.) Similarly, in Am. Handling Equip. Co. v. T.C. Moffatt & Co., 445 A.2d 428 (N.J. Super. App. Div. 1982), the only other case that ACE cited on the exception issue, the insurer filed an answer in an accident case but immediately disclaimed when it discovered, four months later, that the putative insured had no policy with it. Id., at 429. (The broker had not actually obtained the insurance and had made up a policy number. Id., at 430.) The Appellate Division found that the filing of the answer, without any additional activity by the insurer, was a stopgap measure that did not bring the case within the Merchants rule. Id., at 432. See also, United States Cas. Co. v. Home Ins. Co., 192 A.2d 169 (N.J. Super. App. Div.), certif. den., 195 A.2d 121 (1963) (insurer disclaimed coverage five weeks after answer filed; no action in case by insurer after filing of answer). In its opposition to RCM s motion, ACE does not contend that it fairly informed RCM that it met Merchants requirements. By not disputing this point, ACE is simply recognizing reality: Its September 12, 2008 reservation of rights letter 17 says nothing about RCM s right to reject ACE s offer and therefore precludes ACE from claiming that it complied with New Jersey law on an effective reservation of rights. Saddled with an ineffective reservation, ACE argues that the situation here is similar enough to Sussex Mutual and United States Casualty that the 17 Ex. E to RCM s Motion. 22

23 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 23 of 72 narrow exception those cases carve out ought to apply. That is clearly wrong: Instead of the short participation that turns the otherwise conclusive presumption of prejudice into a rebuttable one, ACE was involved in the Topa lawsuit to the very end and never gave up its contractual right to control settlement, which meant that RCM could not settle without ACE s approval. 18 (This latter point will be discussed at greater length soon.) Since ACE appears not to have found any New Jersey cases that carve out other sorts of exceptions to the Merchants conclusive prejudice rule (and we also have not found any), ACE is really asking this Court to create a new exception for insurers who violate Merchants, claim that the insured controlled the defense of the litigation and yet retain their contractual right to settle the lawsuit. As shown above in the statement of facts, RCM hotly disputes ACE s claim that RCM controlled the defense of the Topa litigation. RCM recognizes, however, that the thin reed of the ACE claim handlers testimony is sufficient to create a factual dispute about the control of the defense. But, as RCM stated in its opening memorandum, the Merchants rule is not limited to the defense of a claim but applies to any significant phase of the handling of or resistance 18 ACE s quotes at length from Sussex Mutual, from which it then attempts to draw dispositive parallels to this case, claiming that Sussex Mutual didn t control the defense and neither did ACE; that the insured in Sussex Mutual was aware that coverage was in dispute, and so was RCM; and that the insured in Sussex Mutual had its own attorneys, and so did RCM. (ACE Opp. Memo, at 23.) But in attempting to draw these parallels, ACE ignores that these facts were the underpinning for the Sussex Mutual s court statement that the insured could not have believed that the insurer s filing of an answer amounted to a retreat by the carrier on the coverage question (380 A.2d at 126), an issue that was separate from whether the Merchants conclusive presumption of prejudice rule applied to the filing of an answer as a stopgap measure. Moreover, if the insured s awareness of a coverage dispute and its use of counsel -- the parallels to Sussex Mutual upon which ACE relies -- were determinative factors, the exceptions to Merchants would devour the rule. 23

24 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 24 of 72 to the claim.... Sneed v. Concord Ins. Co., 237 A.2d at 295. Control over settlement is among the significant phases[s] upon with the Merchant rule is premised. Id. See also Griggs v. Bertram, 443 A.2d at 169 (emphasizing insured s inability to try to settle the case without risking loss of coverage pursuant to the provision prohibiting it from voluntarily compromising liability or independently settling the claim ). ACE does not seriously dispute these propositions. Instead, it contends that its failure should not matter for two reasons: first, because RCM participated in the ultimate settlement of the Topa lawsuit; 19 second, because the Policy required RCM s approval of any settlement. 20 (As to the latter, RCM could only consent or not to what ACE had already done. Moreover, if RCM refused, it would be severely penalized if a judgment or later settlement exceeded the proposal.) 21 Both of ACE s arguments miss the point. The Policy provides: The Insured shall not admit or assume liability or settle or negotiate to settle any Claim... without the prior written consent of the Insurer. 22 With ACE proceeding under a reservation of rights, RCM had to wait for ACE to settle the case and could not settle on its own without ACE s permission ACE Opp. Memo, at ACE Opp. Memo, at 20, 84, 87; ACE response to RCM s statement of undisputed facts, at 4 5 (responding to RCM s undisputed fact 39). RCM s statement of undisputed facts and ACE s responses to them are included in the single document that RCM is submitting that collects all of the parties lists of facts and the responses to them. See footnote 1, above. 21 See Ex. A (Policy) to RCM s motion, amended IX, at RCM This provision hardly constitutes control of the settlement by RCM. 22 Policy (Ex. A to RCM s motion), IX.A, RCM See ACE s amended answer, (EX. D to RCM s motion), 31, p

25 Case 2:09-cv AB Document 45 Filed 09/28/10 Page 25 of 72 This is exactly the sort of provision that Merchants and its progeny require an insurer that is proposing to proceed under a reservation of rights tell its insured it can avoid by rejecting the insured s offer and proceeding on its own. The time when compliance with Merchants is required is when the insurer issues its reservation of rights letter, and not later in the case, as ACE contends. 24 In other words, the insured must be told at the time the insurer is attempting to reserve its rights that there is a choice between travelling down the litigation path with the insurer, subject to the reservation, or going on its own, in which case the insured can control defense and settlement. ACE admittedly did not do that. And once ACE failed to comply with Merchants when it sent out its reservation of rights letter, Merchants conclusive prejudice rule applied because of the contractual provision that precluded RCM from settling the case on its own While Merchants and its progeny don t require a showing of prejudice, ACE s retention of the right to go first in settling the Topa lawsuit was not academic. This could have been the sort of case that the Merchants court contemplated when it wrote, Personal counsel may seize opportunities to settle which might be ignored or overlooked by a carrier A.2d at 511. On June 5, 2009, ACE stated in an internal document that damages in the Topa lawsuit could reach $4.5 million and that [t]here is no chance that RCM will be successful at trial and therefore it is crucial to settle this matter. (RCM Memo, at 11, 37; ACE response, at 1.) And although ACE admits that RCM repeatedly insisted that it try to settle the Topa lawsuit (ACE Opp. Memo, at 19, 81 82), ACE does not deny (but instead avoids responding to) RCM s assertion that ACE did not make any settlement offers to Topa until shortly before trial and even offers evidence that ACE actually refused to disclaim coverage so that RCM could settle on its own. (RCM Memo, at 11, 38; ACE response, at 3 4; ACE Exs. 47, 48.) 25 And as a matter of fact, Ms. Kogan' supervisor acknowledged that when ACE has the duty to defend, it has the ability to control settlement, "[t]o analyze and steer the file towards a cost effective resolution for the insured." ACE viewed its duty to pursue settlement as the same regardless of whether the case was being handled by panel counsel or "Cumis counsel". (Ex. KKK (Levine Dep.), at ,116) 25