The Struggle For Control: Who Has the Right To Settle Claims? By Lynda A. Bennett, Esq.

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1 C L A I M DENIED August 2005 A publication of the Lowenstein Sandler Insurance Law Practice Group The Struggle For Control: Who Has the Right To Settle Claims? By Lynda A. Bennett, Esq. One of the archetypal issues that arises in the context of any liability coverage dispute is: who controls the decision to settle or try a case? Not surprisingly, the answer to the question depends on the precise language of the insurance policy under consideration. Many comprehensive general liability policies contain limited language Inside CONTINUED REFINEMENT TO ADDITIONAL INSURED COVERAGE COURT PLACES LIMITS ON INSURER S RESERVATION OF RIGHTS PRESERVING D&O COVERAGE FOR DIRECTORS stating that the insurer has the right to settle claims at its discretion -- thus leaving open for discussion the common scenario where the policyholder wants to settle a claim, but the insurer does not. In those circumstances, the facts and dynamics of the case will determine the policyholder s right to settle, e.g., whether the insurer is providing a defense, whether defense counsel recommends settlement, whether the liability may exceed the limits of the policy if the claim is not resolved, etc. The settlement language contained in niche policies such as Directors & Officers, Employment Practices, or Technology policies is much more detailed and frequently less favorable for policyholders. Those policies contain provisions that are commonly referred to as hammer clauses where the insurer may not have the absolute right to settle a claim, but it may have the ability to unilaterally reduce its exposure for a particular claim. A typical hammer clause states that if the insured does not agree to a settlement that is recommended by the insurer, then the insurer s obligation for the claim is capped at the amount of the acceptable settlement, even though the policy limit may far exceed the settlement amount. For example, assume that an employer purchased Employment Practices Liability ( EPL ) coverage that provides $1 million of limits, subject to a $250,000 retention. A former employee sues the employer for sexual harassment, but is willing to settle for $300,000. The insurer wants to accept the employee s demand. The employer does not want to settle for a variety of reasons including strong defenses to the claim, reputation This document is published by Lowenstein Sandler PC to keep clients informed about current issues. It is intended to provide general information only. A L D

2 concerns, and fear of setting a precedent within its workforce. If the EPL policy contains a hammer clause (and most do), the insurer s liability for the claim is capped at $50,000 and, pursuant to the language contained in many EPL policy hammer clauses, the insurer has no further obligation to defend or reimburse for defense costs. Importantly, the scope of a hammer clause varies significantly depending on policy forms, insurers, and the nature of the liability at issue. For instance, some insurers are willing to exclude application of the hammer clause to certain types of claims. Other insurers are willing to soften the impact of the hammer clause by reducing their exposure to the claim to a fixed percentage of the ultimate loss as opposed to capping their exposure at the amount of the acceptable settlement. Thus, returning to the example above, if the employer takes the case to trial, loses with a judgment of $500,000 entered against it, and incurs $250,000 in defense costs, a modified hammer clause may state that the insurer agrees to pay 50 percent of the total loss in excess of the acceptable settlement amount of $300,000. In that case, the insurer will pay $50,000 toward the acceptable settlement amount (because of the $250,000 retention) and $225,000 toward the total loss that exceeded the acceptable settlement amount. The remaining $475,000 would be borne by the employer. In order to avoid surprises and struggles for control with insurers after a claim is made, policyholders must pay careful attention to any policy language that governs the ability to settle claims and seek to obtain the greatest level of control over settlement without losing the value of the insurance coverage for which significant premiums are being paid. PRESERVING D&O COVERAGE FOR DIRECTORS For the first time, independent directors have paid millions of dollars out of their own pockets to settle corporate mismanagement claims. Simultaneously, Sarbanes-Oxley has imposed onerous new responsibilities with concomitant exposures. Directors are justifiably concerned whether they have sufficient directors and officers ( D&O ) insurance coverage if they are sued. One issue for directors is that numerous parties may share a single limit. Most current D&O policies provide coverage not only for the directors and officers but also for the corporation itself. If all of the directors and officers and the corporation are sued simultaneously, what looked like a substantial amount of coverage can vanish quickly just on attorneys fees. Moreover, in several recent cases, the corporation and the individuals have fought over access to the D&O policy. This is particularly true in the bankruptcy context, where the trustee can claim the D&O insurance policy as an asset. An independent insurance policy providing coverage solely to the directors can provide a substantial measure of comfort, and make it easier for a company to recruit outside directors. The insurance industry is offering innovative products to address these concerns. One such solution is the purchase of separate Side A coverage. Side A coverage refers to the coverage for directors for liability not indemnified by the corporation. This insurance can solely be accessed by the directors - there is no possibility of a claim against it by the corporation or the bankruptcy trustee. The coverage cannot be rescinded by the corporation. Chubb now offers a D&O policy with an option that permits the insured to dedicate a portion of the limits solely to individual insureds. AIG offers a D&O policy just for independent directors that becomes first dollar coverage should the corporation refuse

3 to indemnify or the traditional D&O become unavailable because of rescission or other refusal or inability of the D&O insurer to pay. An independent insurance policy providing coverage solely to the directors can provide a substantial measure of comfort, and make it easier for a company to recruit outside directors. CONTINUED REFINEMENT TO ADDITIONAL INSURED COVERAGE By Lynda A. Bennett, Esq. Additional insured coverage is one of the leading issues in our practice today. Landlords, contractors, suppliers, manufacturers, and a host of other commercial entities enter into contracts every day that require issuance of additional insured endorsements. Typically, however, no one takes the time to read the endorsement or the policy to determine just how much coverage is conferred to the additional insured until after a claim is made. Many times, the party issuing the additional insured endorsement and its insurer are dismayed to learn that more coverage is available to the additional insured than was intended. During the past several years, the insurance industry has made several modifications to standard comprehensive general liability ( CGL ) forms in an effort to limit insurers exposure for additional insured claims. While much attention has focused on language addressing direct versus vicarious liability of the additional insured, insurers are also placing limits on coverage in the contractual liability coverage grants. Many times, the party issuing the additional insured endorsement and its insurer are dismayed to learn that more coverage is available to the additional insured than was intended. For example, we recently reviewed an ISO policy form for a client that contained a substantial cutback in overall coverage when an additional insured has the right to a defense under the policy. The policy conferred blanket additional insured coverage to all persons or organizations that the client was obligated to name as an additional insured under its CGL policy pursuant to an insured contract. However, the ISO form stated that solely for purposes of liability assumed in an insured contract, reasonable attorneys fees and necessary litigation expenses incurred by or for a party other than an insured are deemed to be damages In other words, any defense costs paid on behalf of an additional insured are construed as damages and therefore erode the limit of liability available under the policy. This modification is a significant departure from the traditional defense coverage available under primary CGL policies where defense costs are paid outside of the limits. Depending on the number of insured contracts that the company enters, the amount of limits secured, and the loss experience in a particular year, the impact of the modification could be tremendous. Complex commercial litigation has become an expensive proposition from a defense cost perspective. Moreover, because CGL policies typically do not contain priority of payment provisions that preserve limits for the named insured in a claim involving multiple insureds, a company may find itself in the precarious position of having paid large sums of money to buy insurance that is used to protect others. To mitigate these risks, policyholders conferring additional insured status should consider implementing one or more of the following best practices. First, limit the number of contracts under which the company is obligated to provide additional insured coverage. Second, in industries where additional insured requirements are standard fare, secure CGL coverage from insurers that do not modify the defense cost coverage provided to additional

4 insureds. Third, to the extent that the company is required to accept the defense cost modification and no other viable insurance source exists, secure primary limits of liability and/or excess coverage that is sufficient to cover the company s overall risk exposure. Fourth, limit the scope of indemnity provided under the insured contract to exclude or cap a defense cost obligation. Finally, include a priority of payment provision in the insured contract establishing that the party providing coverage to an additional insured has first priority to the limits of liability in a multiple insured claim scenario. Of course, the party receiving additional insured status must review the insurance policy to try to prevent the named insured from taking many of these steps. COURT PLACES LIMITS ON INSURER S RESERVATION OF RIGHTS When a company places its insurer on notice of a new complaint, the insurer rarely acknowledges that it will defend and indemnify its insured. Rather, the insurer typically states that it will defend under a reservation of rights. Nobody is quite sure what defending under a reservation of rights means in New Jersey - specifically what rights are reserved and for how long? The recent trial court decision in Rubin & Kaplan v. Harleysville Insurance Company, MID-L (Middlesex County February 18, 2005) has shed some welcomed light. Insurers frequently take many months simply to respond to their insureds, and almost always fail to follow up on reservations of rights in a timely manner. In Rubin & Kaplan, the insurer defended under a reservation of rights, and then denied coverage and withdrew from defense 39 months later, just weeks before the trial. Moreover, no new facts had emerged - the insurer could have disclaimed coverage on the same grounds on day one. The court was not sympathetic to the insurer s position. Most importantly, the court held that the insurer was estopped by its conduct from denying coverage. The court found that the insured was prejudiced by having the insurer control the defense for so long. Second, the court held that when the insurer reserved its rights, it did not adequately inform the insured that it had the option of turning down the insurer s conditional offer of a defense and could instead defend itself and sue for coverage. Insurers frequently take many months simply to respond to their insureds, and almost always fail to follow up on reservations of rights in a timely manner. Rubin & Kaplan provides important ammunition for the company stuck with an unresponsive insurer. ADVERTISING INJURY COVERAGE: GOOD NEWS, BAD NEWS Historically, general liability policies did not define advertising, and insurers and insureds have fought for years over what types of marketing activity constituted covered advertising injury. As new advertising media have become available, the battles have become even more intense. The U.S. Fourth Circuit Court of Appeals has now decided an issue of first impression involving websites in favor of the insured. Teletronics Int l, Inc. v. CNA Ins. Co., 120 Fed. Appx. 440 (4th Cir. 2005) involved an infringing product manual placed by the insured on its website. The insured was sued by a competitor for copyright infringement, and its insurer refused to defend the claim. The insured s policy provided coverage for advertising injury but the term advertising was not defined in the policy. The insured argued that it only placed items on its website for

5 marketing purposes and therefore the claims arose from advertising activities by the insured. The insurer asserted that websites served many purposes, and that the manual could be informational for customers without being advertising. The court sided with the insured, stating that the insured was clearly engaged in conduct amounting to personal solicitation, encompassed within the common definition of advertising. The bad news is that for several years, the insurance industry has been reducing advertising injury coverage, and most companies no longer have the broad type of coverage discussed in Teletronics. On the one hand, specific website and Internet restrictions are appearing in policies. Simultaneously, insurers are defining advertising so it only applies, for example, to mass market print marketing. PREMISES LIABILITY ASBESTOS CLAIMS Until recently, asbestos liability meant products liability. Recently, though, companies who never manufactured, distributed or sold asbestos find themselves subject to hundreds of premises liability asbestos claims. These are claims by independent contractors who worked over time in numerous warehouses or factories, and who now sue all of the owners of those workplaces for asbestos exposure. An insulator may claim that he installed insulation containing asbestos at 50 warehouses during his work career, and sue all of those companies. Products liability vs. premises liability has a tremendous impact on insurance coverage. Historically, most general liability policies provided coverage separately for products liability and premises liability. A company may have had its products liability coverage exhausted by asbestos claims, but have its premises liability limit untouched. Classifying asbestos claims as premises liability instead of products can have another benefit. Many standard general liability policies state, in the Limits of Liability provision of the policy, that the policy s aggregate limit for bodily injury only applies to product liability and completed operations claims, and not premises liability claims. Thus, the policy must respond to an infinite number of occurrences, and cannot be exhausted. This forces the insured to grapple with the number of occurrences issue, probably the most hotly contested insurance dispute at the current time. Assume that a company has received 10,000 premises asbestos bodily injury claims at twenty different locations. Is that one occurrence, 20 occurrences, or 10,000 occurrences? Courts are in total disagreement. Why does this matter? In the above hypothetical, if the insurance policy does not have a deductible or aggregate and each claim is a separate occurrence, and each claim settles for $5,000, the insured has infinite coverage. If we change one fact, and just add a $5,000 per occurrence deductible, the insured has no coverage instead, because each claim is an occurrence that settles within the per occurrence deductible. In Appalachian Insurance Co. v. General Electric Co., 2005 N.Y. App. Div Lexis 6531, GE was insured by a primary insurer with which it was affiliated, and which had a per occurrence limit with no aggregate. GE therefore sought to characterize all of its asbestos claims as a single occurrence in order to exhaust the per occurrence limit of the primary policy and reach the excess insurance program. The New York Appellate Division held instead that each asbestos claim was a separate occurrence. Since each individual asbestos claim settled within the per occurrence limit of the primary policy, GE could never reach the excess coverage. Any company facing asbestos, silica, or other mass tort claims must carefully examine its insurance program in light of the prevailing law in order to maximize insurance coverage.

6 Publications Managing Your Insurance Broker: Promises and Potential Liability, Commerce Magazine, Robert D. Chesler, Esq., July D&O Insurance Now You See It Now You Don t, The Metropolitan Corporate Counsel, Robert D. Chesler, Esq. and Cindy R. Tzvi, Esq., June Directors and Officers Beware: Will Your Company s D&O Insurance Policy Be There When You Need It Most?, The Metropolitan Corporate Counsel, Lynda A. Bennett, Esq. and William M. Uptegrove, Esq. May Upcoming Events NJICLE Broker Liability Seminar, September 27, 2005, Edison, N.J. Recent Outpost Legal Highlights New Jersey Court Favors PLIGA in Recent Statutory Interpretations Shooting Accident Held Covered by Homeowner Policy Untimely Notice by a Matter of Hours Results in Forfeiture of Coverage Under a Claims Made Policy J Insurance Coverage Practice Group 65 Livingston Avenue Roseland, New Jersey Presorted First Class Mail US Postage PAID Permit #73 West Caldwell, NJ