Friday, June 16, 2017

United States District Court holds that the reference proceeding statute is constitutional

I've been discussing in my last two posts Bearbones, Inc. d/b/a Morningside Bakery v. Peerless Indem. Ins. Co., 2016 WL 5928799 (D. Mass.) (unpublished), a federal court case alleging bad faith practices by an insurer, Peerless, before and during a reference proceeding.

The plaintiffs sought a declaration that the reference proceeding statute, Mass. Gen. Laws ch. 175 §99, ¶Twelvth, violates Article 11 of the Declaration of Rights of the Massachusetts Constitution, which guarantees the right "to obtain right and justice freely, and without being obliged to purchase it, completely, and without any denial, promptly, and without delay; conformably to the laws."  Specifically they alleged that the reference proceeding statute violates Article 11 because it requires that insureds pay for referees and because referees, rather than judges determine the amount of the loss. 

The court noted that the free access to courts clause of Article 11 "requires that all cases be decided by a judge, and that litigants need not 'purchase' access to justice."

Using logic that strikes me as disingenuous, the court held that, unlike a probate court matter in which the court appointed a parent coordinator with binding authority to resolve conflicts between divorcing parents, the reference proceeding did not take place over the objection of either party.  Rather, the plaintiffs made a business decision to purchase casualty insurance.  Pursuant to the policy both parties agreed to submit disputes over the amount of loss to a reference proceeding.

While it is true that parties can agree to alternative dispute resolution clauses in a contract, that is not quite what happened here.  Rather, the reference proceeding statute requires that disputes over the amount of loss under certain insurance policies must be determined by a reference proceeding.  That is why the requirement is in the property policies.  The parties are not allowed to negotiate over it. 

While it may be true that the plaintiffs did not have to purchase property insurance -- and that is probably not the case, as mortgages require property insurance -- it is not true that the parties included the reference proceeding clause by their own free will.

The court also notes in a footnote that the plaintiffs failed to allege that they incurred any costs in connection with the reference proceeding.  In their motion to amend the complaint they argued that the reference proceeding statute requires an insured to expend significant sums of money to pay for referees and that the plaintiffs paid over $30,000 in fees to the referees.  The court asserts that there were no supporting allegations in the supplemental complaint. 

That seems overly harsh to me.  The reference proceedings statute provides that of the three referees, the insureds will pay the fee of the first, the insurer will pay the fee of the second, and they will split the fee of the third.

The court then held that the "no purchase of justice" provision of Article 11 is to guarantee that "all litigants similarly situated may appeal to the courts both for relief and for defense under like conditions and with like protection and without discrimination."  A statute that "does not pertain to a suspect class, . . . involves a right . . . that is not fundamental, . . . and is rationally related to achieving its purpose . . . passes constitutional muster."

The court noted that the plaintiffs have not alleged that they are being treated differently than any other class of insureds under policies issued with the same mandatory language, or that they are part of a suspect class.  It also noted that free access to courts is not a fundamental right.  Therefore, the reference proceeding statute need only be rationally related to achieving its purpose.  The plaintiffs did not allege that the requirement of a reference proceeding is not rationally related to achieving the purpose of establishing a summary method of establishing the amount of loss.

I agree that the reference proceeding statute is rationally related to the purpose of having a summary method of establishing the amount of a property loss.  I nevertheless am trouble by the decision -- or perhaps by the earlier decision quoted by the court holding that access to courts is not a fundamental right.  If that's the case, then why is it part of the Massachusetts Declaration of Rights?  I'm not a constitutional law scholar, but it seems to me that the legislature should not be able to take away a right protected by the constitution.  Moreover, does this mean that the legislature can decide that parties to a tort case don't have  a right to a judicial hearing?  How about contract cases?  

Wednesday, June 14, 2017

Federal Court denies motion to amend complaint to add new allegations of bad faith settlement practices based on facts that did not exist when lawsuit was filed



In my last post I discussed Bearbones, Inc. d/b/a Morningside Bakery v. Peerless Indem. Ins. Co., 2016 WL 5928799 (D. Mass.) (unpublished), a property damage case in which the plaintiff insureds sued the insurer, Peerless, in federal court while a reference proceeding was pending.  After the reference proceeding the plaintiffs sought to file a supplemental complaint in the federal court case.

The proposed supplemental complaint alleged that during the reference proceeding Peerless engaged in various acts of trickery or deceit, including harassing the plaintiffs with requests for false stipulations which could result in them waiving their claims, and falsely claiming it never received written discovery from them. 

The court held that such actions would not represent a separate violation but a continued course of conduct that began before the lawsuit commenced.  On that ground the court denied the addition of the proposed additional count alleging such conduct.  

While I understand the logic that continuing conduct is not a separate violation, it seems to me that the plaintiffs should be allowed to amend their complaint to allege new facts in support of the allegations of bad faith settlement practices. 


Monday, June 12, 2017

US District Court holds that cross-examination is proper remedy for biased experts testifying on behalf of insurer

Morningside operated a bakery inside a commercial condominium unit owned by Amaral Enterprises.  On February 19, 2013, water from a burst pipe allegedly caused a $1.5 million loss at the bakery.  Morningside and Amaral filed a claim with their insurer, Peerless Insurance. That claim proceeded to a reference proceeding, an arbitration required by Mass. Gen. Laws ch. 175 §99, ¶Twelvth in certain property loss claims.

In the meantime, on February 6, 2015 the plaintiffs sued Peerless in federal court, seeking a declaratory judgment that Peerless is obligated to cover the losses, for breach of contract, and for unfair claims settlement practices in breach of Mass. Gen. Laws ch. 93A.

On July 6, 2015, the referees returned an award of about $93,000.  After the award the plaintiffs moved to file a supplemental complaint in the federal court action, alleging additional violations of ch. 93A.  Specifically, the plaintiffs alleged that they were subjected to unfair claims settlement practices because at the reference proceeding Peerless called two witnesses it claimed were experts, but who were neither independent or objective.  One was a certified public accountant who has worked for Peerless and its parent company, Liberty Mutual, her entire career.  The other was a CPA who was in a business partnership with the attorney representing Peerless.

The plaintiffs also alleged that Peerless refused to resolve their claim and engaged in various acts of trickery or deceit, including harassing them with requests for false stipulations which could result in the plaintiffs waiving their claims, and falsely claiming it never received written discovery from the plaintiff.

The plaintiffs also sought a declaration that the reference proceeding statute violates Article 11 of the Declaration of Rights of the Massachusetts Constitution, which guarantees the right "to obtain right and justice freely, and without being obliged to purchase it, completely, and without any denial, promptly, and without delay; conformably to the laws."  I will discuss the "trickery and deceit" allegations and the constitutional argument in future posts.  

In Bearbones, Inc. d/b/a Morningside Bakery v. Peerless Indem. Ins. Co., 2016 WL 5928799 (D. Mass.) (unpublished), the United States District Court for the District of Massachusetts addressed the motion of the plaintiffs to amend the complaint.  It held that the proposed supplemental complaint did not set forth sufficient facts to support an inference that Peerless acted in an unfair, fraudulent, or deceptive manner in relation to testimony by its experts.  "There is nothing improper (or even unusual) about a company eliciting testimony from an employee about a transaction or occurrence in issue, including testimony that draws on that employees particular area of expertise, such as accounting."  The court held that the proper remedy for potential bias is cross-examination.  Similarly, an expert may be impeached with respect to his or her financial interests in the case.

Friday, May 19, 2017

Bankruptcy court holds that bank can apply insurance proceeds to outstanding loan of borrower in default on loan

Nadler & Darwish, a company that was in bankruptcy proceedings, was in default on mortgages on property it owned.  After a fire its insurer issued a check for $165,000.  Following standard procedure, the insurer issued the check jointly to Nadler & Darwish, the insurance adjuster (probably a public adjuster, who advocates for an insured in property loss cases and is entitled to a percentage of the loss paid) and Mechanics Cooperative Bank, the bank that held the mortgages on the property.

The bank endorsed the check on Nadler & Darwish's behalf, deposited it, paid the adjuster's commission, and then used the rest to reduce Nadler & Darwish's outstanding loan obligations to the bank.

Nadler & Darwish moved that the bank be ordered to repay the amount of the check except the adjuster's commission.  In In re Nadler & Darwish, LLC, 2016 WL 5396652 (D. Mass.) (unpublished), the Bankruptcy Court ruled in favor of the bank.  It held that under Massachusetts statute and case law, when a mortgage is in default and  a fire destroys the property, the mortgage bank can assert its rights with respect to the proceeds of the insurance policy as the intended third-party beneficiary of the policy.  Although a check made out to more than one party can only be cashed if all the parties endorse it, under the mortgage documents the bank was given power of attorney that allowed it to sign on behalf of Nadler & Darwish. 

Friday, May 5, 2017

United States District Court for the District of Massachusetts holds that two year period for replacing property under replacement cost and ordinance and law coverage is not tolled by ACV payment delays caused by insured


Policies insuring property damage to buildings owned by the insured typically divide payment of loss into three coverages.  The insurer will initially pay the actual cash value (the "ACV") of the loss, which means the value of the damaged property at the time of the loss.  Then, once the property is actually repaired or replaced, insureds who have replacement cost coverage will receive the difference between the actual cash value and the reasonable amount they paid to repair or replace the property.

In a fire loss, for example, the insurer will first pay the actual cash value of the beat up, cat scratched armchairs (not that I'm projecting).  It will pay the difference between that and the cost of the new, not yet (but doubtless soon to be) scratched armchairs when the insured submits receipts that the new armchairs were purchased.  Insurance policies typically provide that replacement cost coverage will only be paid on repairs or replacements made within two years of the loss.

A third type of coverage, "Ordinance or Law" coverage, applies to the cost of bringing a building up to current codes.  Older buildings are often not compliant with current safety standards set forth in sanitary and health codes.  The buildings are "grandfathered in," meaning that the owners are usually not required to make changes that bring the buildings up to current standards. 

But once a certain amount of money is spent on a building, they are required to be brought up to current code.  (As a side note, that's why some buildings fall into worse and worse disrepair.  The owners may be able to afford to put a few thousand dollars into an electrical system, but once they do that they have to bring the entire building up to code.  That can cost many times as much as the original repairs.)

Ordinance or Law Coverage, like replacement cost coverage, is often limited to repairs made within two years of the loss.

When there is a dispute over the amount of loss in a property damage case, that amount will often be determined by a specialized type of arbitration called a reference proceeding.

One issue that often arises is whether the two year time limit to repair or replace property for replacement cost coverage and Ordinance or Law coverage to kick in is extended when an insurer's payment of the actual cash value is so untimely that the insured cannot afford to repair or replace the property within two years.

In Shri Gayatri, LLC v. Charter Oak Fire Ins. Co., 206 F. Supp.3d 684 (D. Mass. 2016) the United States District Court for the District of Massachusetts held that the time to repair or replace the damaged property was not tolled by a delay in payment of the actual cash value.  The reason for that holding was that the delay in payment was the a result of the insured's own delays and failures to communicate with the insurer. 

Tuesday, April 25, 2017

Massachusetts Superior Court holds that insurer cannot retroactively recoup defense costs but can refuse to pay costs that have been incurred

The April 17, 2017 issue of Massachusetts Lawyers Weekly quoted me (password required) in an article about a decision by the Massachusetts Superior Court, Holyoke Mutual Ins. Co. In Salem v. Vibram USA, 2017 WL 1336600 (Mass. Super.)  

That case holds that if an insurer agrees to defend its policyholder in a claim and then wins a separate declaratory judgment action determining that it has no duty to defend, the insurer is not entitled to recoup the defense costs it has already paid out.  That is an important holding on a question that has been unsettled in Massachusetts.

As I discussed in the Lawyers Weekly article, the case also holds, in my opinion contradictorily, that the insurer does not have to pay defense costs that have been incurred but not paid by the time of the ruling that there is no duty to defend.  There is no indication in the decision that the insurer had given notice to the policyholder before the bills were incurred that it did not intend to pay them.  The distinction between bills that had been submitted and paid by the insurer and bills that had been submitted and not yet paid by the insurer seems like a random one. 

In Vibram, the policyholder had exercised its right to control its own defense by hiring counsel of its choice, who would be paid by the insurer.  It was entitled to do so because the insurer was defending under a reservation of its right to later deny coverage. 

The court held that the fact that the policyholder was controlling its own defense meant that it was not harmed by the retroactive decision of the insurer not to pay bills that had already been incurred. 

The policyholder was Vibram USA, a large corporation with significant resources.  (I am a big fan of Vibram's  barefoot sneakers.)  But elsewhere in the decision the court appropriately pointed out that the resources of the policyholder should not be a factor in determining the duty of the insurer, because similar policies are issued to individuals and small businesses and the insurer has the same duty to all policyholders.  Yet the court did not take into account that an individual or a small business might make a different decision about what kind of defense costs to incur if it understands an insurer will pay those costs than if it has been told by the insurer that it will not pay those costs. 

The court explained its rationale in part by holding that “there is nothing inherent in an insurer’s initial decision to provide a defense that precludes it from changing its mind, even while a declaratory judgment action is still pending.” That is certainly a correct statement of law.  But, as the court pointed out earlier in the decision, “[i]n the first instance, it is for the insurer to determine whether any of the allegations of the complaint, if proved, could support a claim covered by the policy.  If it declines to provide a defense, it faces potential liabilities that will likely exceed the cost of defense.”  Those liabilities are ch. 93A damages that can be awarded for breach of a duty to defend, and fee shifting in a declaratory judgment action over the duty to defend if the policyholder prevails. 

The court cited Herbert A. Sullivan v. Utica Mut. Ins. Co.,439 Mass. 387, 395 (2003) for the proposition that an insured can change its mind about whether it has a duty to defend.  But in Herbert A. Sullivan  the insurer did not change its mind – the circumstances changed.  The initial complaint in that case alleged negligence, a claim that was covered under the policy.  The amended complaint eliminated the negligence claim, and none of the remaining allegations involved covered losses.   

The coverage question at issue in Vibram was whether a policy provision covering Advertising Injury included coverage for a claim based on the unauthorized use by the policyholder of a famous person’s name to sell the policyholder’s product.  The court does not indicate that any circumstances changed that would affect that analysis.  While an insurer is entitled to revisit its own legal analysis, I did not see in the decision any rationale for allowing it to do so retroactively.     

As I told Lawyers Weekly, the court’s holding that an insurer can retroactively refuse to pay defense costs that have already been incurred allows an insurer to have its cake and eat it too.  It can agree to defend under a reservation of rights, thereby avoiding potential ch. 93A damages for breaching a duty to defend, while also not paying  the defense costs it agreed to pay, perhaps ever. 

Tuesday, March 28, 2017

United States District Court holds insurer has duty to defend allegation of defective product

Michael Ladas alleged in a suit against IMS that it had manufactured non-compliant and defective components of a product made for the United States army, in violation of the federal False Claims Act.  (What that product was, as well as other facts, has been redacted from the publicly available version of the court's opinion.)  The underlying suit eventually settled, after IMS had spent more than $400,000 in legal fees. 

IMS had sought coverage from its insurer, All America.  All America denied a duty to defend or indemnify.  In Innovative Mold Solutions, Inc. v. All America Ins. Co., Inc., 2016 WL 3814774 (D. Mass. 2016), the United States District Court held that All America had violated its duty to defend.

Because of the redactions it is somewhat difficult to follow the court's analysis.  The first question before it was whether the damage alleged was covered property damage.  The issue was whether the damage was to property that belonged to someone other than IMS, since faulty workmanship to an insured's own product is not covered.  The court held that there was a duty to defend because the underlying complaint alleged that faulty epoxy potentially caused damage to components that were supplied by other entities.

The next issue was whether the underlying complaint alleged an occurrence within the meaning of the policy.  All America argued that IMS changed the composition and application of epoxy, which was an intentional act and not an occurrence.  IMS asserted that the injury was an occurrence because it had not intended the injury.  The court agreed with IMS.

Finally, the court held that the faulty workmanship exclusions did not apply.  Exclusion j(6) does not apply to property damage included in the products-completed operations hazards, which means that it does not apply to property damage that occurs away from premises owned or rented by the insured.  The other faulty workmanship exclusions do not apply to damage to property owned by someone other than IMS.