Superior Court discusses "arising out of"

My first foray into insurance coverage issues was when, as a young insurance defense associate, I argued the meaning of the phrase "arising out of" in an insurance policy to the First Circuit Court of Appeals. I convinced the court that the phrase denoted intermediate causation--more than causation-in-fact but less than proximate cause--such that a construction site accident injuring the employee of the insured subcontractor "arose out of" the subcontractor's work even though the subcontractor did not proximately cause the accident.

Mike Tracy of Rudolph Friedmann LLP has sent me over the latest foray into "arising out of."

In Massachusetts Property Ins. Underwriting Ass'n v. Gallagher, 2009 WL 2568547, 18 year old Stephen McMaster died in an apparent suicide after ingesting an overdose of propoxyphene. Gallagher's mother sued Scaduto, alleging that Scaduto had negligently left the drug in a place in his home accessible to McMaster, despite knowing of McMaster's fragile emotional state. At issue in the Massachusetts Superior Court was whether Scaduto was covered by his homeowner's policy.

The policy excluded bodily injury "arising out of the use, sale, manufacture, delivery, transfer or possession by any person of [] Controlled Substance(s). . . . However, this exclusion does not apply to the legitimate use of prescription drugs by a person following the orders of a licensed physician."

The court noted that the phrase "arising out of" suggests causation analogous to "but for" causation.

It rejected Gallagher's argument that McMaster's death came within the exception to the exclusion because it "arose out of" Scaduto's legitimate prescription use of the drug.

The court held that there was a "separate and independent" application of the exclusion to McMaster's own use of the drug. McMaster's use of the drug came within the exclusion and did not fall within the exception. There was therefore no coverage under the policy.

The answer to a nagging duty to defend issue

As I discussed here, the duty of an insurer to defend an insured is determined by the "eight corners test." Under that test, "if the allegations of the complaint are 'reasonably susceptible' of an interpretation that they state or adumbrate a claim covered by the policy terms, the insurer has a duty to defend." (The "eight corners" comes from comparing the four corners of the complaint to the four corners of the insurance policy.)

But what about when the allegations of the underlying complaint are silent as to an issue that is important for determining coverage? For example, what if the insurance policy provides coverage for all blue cars owned by Lucy Smith? Smith is sued following a motor vehicle accident. The underlying complaint will probably allege the make and model of the car Smith was driving, but it is unlikely to state the color of the car because the color is irrelevant to Smith's liability. Can the insurer refuse to defend because its investigation reveals that the car Smith was driving at the time of the accident was yellow, and so not covered by the "blue car policy"?

Yes. In Farm Family Mut. Ins. Co. v. Whelpley, 54 Mass. App. Ct. 743, 747 (2002), the court held that there is an exception to the eight corners test for "the existence of an undisputed extrinsic fact that takes the case outside the coverage and that will not be litigated at trial of the underlying action."

Massachusetts Appeals Court holds that misrepresentation on bond application that insured had internal auditor does not void coverage

In my last post I began discussing Hanover Ins. Co. v. Treasurer and Receiver General, 74 Mass. App. Ct. 725 (2009), in which the Massachusetts Appeals Court discussed when misrepresentations on a bond application can void coverage.

Hanover argued that coverage was voided because the Massachusetts Treasury Department stated on its application that an internal audit was conducted by the State Auditor, but that in fact there was no internal auditor.

The accounting firm of Deloitte & Touche conducted annual independent audits of the state government departments, and sent its reports to the State Auditor. The State Auditor also conducted reviews of the Department every three or four years. The Deloitte & Touche audits were "external" audits while the audits of the State Auditor were "internal" audits.

Hanover never inquired about the frequency of internal audits and never informed the department that they must be done annually.

The court held that the inaccurate representation that there was an internal auditor was not material.

Massachusetts Appeals Court holds that de minimis departure from representation on bond application does not void coverage

In Hanover Ins. Co. v. Treasurer and Receiver Gen., 74 Mass. App. Ct. 725 (2009) Hanover issued employee dishonesty bonds from 1993 to 1999 to the Massachusetts Treasurer's Department. The bonds covered losses caused by the dishonesty of any department employee.

In February, 1999, the Attorney General's office began an investigation that determined that a Treasury department employee, Trischitta, had stolen $6.5 million from the department's unpaid check fund ("UCF"). The department recovered the full amount of the stolen funds, plus interest.

With Trischitta's cooperation the department discovered that he was not the only department employee stealing money from the UCF. The department gave notice to Hanover of the claim on March 19, 1999. Hanover refused to make payment on the bonds, and filed a declaratory judgment action.

Hanover first argued that the department made misrepresentations in its bond applications that (1) there was independent reconciliation of bank accounts; (2) it had an internal auditor; and (3) there was a voucher system in place to prevent the unauthorized issuance of checks.

The court noted that pursuant to Mass. Gen. Laws ch. 175 § 186, an insurer may not refuse to pay a claim on the grounds of misrepresentation in a policy application unless the misrepresentation "is made with actual intent to deceive, or unless the matter misrepresented or made a warranty increased the risk of loss."

The court held that Hanover had the burden of proof on those issues.

In determining whether a misrepresentation increased a risk of loss, "a fact must be regarded as material, the knowledge or ignorance of which would naturally influence the judgment of the underwriter in making the contract at all, or in estimating the degree and character of the risk or in fixing the rate of the premium."

The department had stated on its application that bank accounts were reconciled monthly by someone not authorized to deposit or withdraw funds. The trial judge had found that the department's contract with a bank to provide bank reconciliations services satisfied the department's representation on the applications. Hanover argued that the reconciliation service did not include checks issued by the UCF, demonstrating lack of substantial compliance.

The Appeals Court disagreed with Hanover, noting that no one in the department with appropriate authority was aware that the UCF was not included in the bank's reconciliation services, and that the number of checks not reconciled was de minimis (one tenth of one percent) compared to the total number of checks. The court held that the representation was therefore substantially true and the department was in substantial compliance with its representation.

U.S. District Court explains difference between liability and indemnity policies

In my last couple of posts I have been writing about Mut. Ins. Co. v. Murphy, in which the United States District Court for the District of Massachusetts held that an insurer that did not exercise control over defense and settlement of a claim could not be liable for unfair claim settlement practices.

The decision contains an interesting discussion about the difference between liability policies and indemnity policies. A liability policy confers the right to settle and defend any claims on the insurer. An indemnity policy leaves the duty to settle and defend on the insured.

The court described the Mutual policy at issue, which I described in detail in my last post, as a "hybrid" because the insurer could associate with defense and settlement of claims but the insured was not excluded from participating in the defense and indemnity.

U.S. District Court holds that insurer that did not control defense could not be liable for unfair claims settlement practices

In my last post I discussed the decision of the United States District Court for the District of Massachusetts in Mut. Ins. Co. v. Murphy, in which the court dismissed Judge Murphy's claim against the Boston Herald's insurer for unfair claims settlement practices. The reason for that decision was that the insurer did not have control over defense or settlement of the claims.

The Herald was insured under a "media insurance policy" issued by Mutual Insurance Co. for damages arising out of libel. The policy had a $50,000 self-insured retention (similar to a deductible). After the first $50,000, the Herald would continue to pay twenty percent of defense expenses up to $500,000.

Under the policy the Herald had s duty to retain its own counsel for the defense or settlement of a claim, although choice of counsel was subject to the approval of Mutual. The Herald was also obligated to advise Mutual of the likelihood of success or failure, provide an initial estimate of legal costs, and advise it of offers of settlement and other information pertinent to a claim. The Herald was also required to notify Mutual when it became clear that a claim was like to exceed $50,000, and regularly to update it as to expenses.

As to Mutual's obligations, the policy stated, "The company shall not be called upon to assume charge of the settlement, or the defense of any claim made, or suit brought, or proceeding instituted against the insured."

Under the policy Mutual had the right to associate with the Herald in defense and control of any claim which appears likely to involve payment by Mutual, in which event the Herald and Mutual were required to cooperate in defense or settlement of the claim; or, if Mutual was dissatisfied with the Herald's choice of counsel, to suggest replacement with new counsel to be jointly approved by Mutual and the Herald. No settlement could be made without Mutual's consent, but Mutual could not unreasonably deny consent. If judgment entered against the Herald and the Herald chose not to appeal, Mutual could appeal the judgment.

The court held that those policy clauses did not give Mutual control over defense or settlement sufficient to make it liable for unfair claims settlement practices.

U.S. District Court rules on Judge Ernest Murphy's claim against Boston Herald's insurer

Another chapter in the long, sometimes strange story of former Massachusetts Superior Court Judge Ernest Murphy's libel suit against the Boston Herald:

The Boston Herald published a story claiming that Judge Murphy had told a 14year old rape victim to "get over it." Judge Murphy sued the Herald for libel and won. He then sent somewhat threatening letters directly to the Herald (rather than its attorneys) on trial court stationery demanding that it drop its appeal. (Contrary to what you might sometimes see on TV, parties in a lawsuit are forbidden from communicating directly with each other; they may communicate only through their attorneys. And judges are forbidden from communicating personal business on court stationery.)

The judge subsequently asserted that he suffered from post-traumatic stress syndrome as a result of the Herald's articles and entered into an agreement with the Superior Court by which he agreed that he is permanently disabled from performing his judicial duties.

The most recent chapter in this case is Judge Murphy's lawsuit against the Herald's insurer, in which he sought damages for the insurer's failure to promptly settle his libel claim. The United States District Court for the District of Massachusetts has dismissed his claim in Mut. Ins. Co. v. Murphy, on the grounds that the Herald rather than the insurer exercised control over the defense.

Court of Appeals holds that insurers who issued claims-made policies are not required to show prejudice as a result of late notice of claim

This is my last post on Gargano v. Liberty Int'l Underwriters, Inc., in which the United States Court of Appeals held that insurers could under claims-made policies claims that were not both made and reported during the policy period.

The plaintiff argued that the insurers must demonstrate prejudice from his untimely notice in order to escape their coverage obligations. Although with occurrence based policies it is the rule in Massachusetts that an insurer must show prejudice from late notice, the court held that the same is not true of claims-made policies. To do so "would defeat the fundamental concept on which claims-made polices are premised."