?? Fall 2024

Greetings to everyone in Insurance Land. Here is the Fall 2024 edition of my Coverage Review newsletter with the top eight things that I want you to know about insurance right now.

This newsletter is 3,127 words, a 13.1-minute read.

1. ? Court Enforces Additional Insured Endorsement for Vicarious Liability Only

A New York appellate court held that a subcontractor’s insurance policy did not provide additional insured coverage for a general contractor because the underlying bodily injury claimant did not allege that the general contractor was vicariously liable for the subcontractor’s conduct.

Why it matters: Some courts have been hesitant, on illusory coverage grounds, to enforce additional insured endorsements that provide coverage for only the additional insured’s vicarious liability for the named insured’s negligence. This decision provides support for these endorsements.

Here’s what’s up: A general contractor hired a subcontractor to perform certain work at a construction project site.

• The subcontractor agreed to obtain additional insured coverage for the general contractor.
• The subcontractor’s insurance policy had an additional insured endorsement that included included certain entities as additional insured but only “[t]o the extent that such additional insured is held liable for your [the named insured subcontractor’s] acts or omissions arising out of and in the course of ongoing operations performed by you or your subcontractors for such additional insured.”

The appellate court’s conclusion: “[T]he language of the additional insured endorsement covered only the [general contractor’s] vicarious liability for the acts of [subcontractor], and since the court in the underlying action determined that [plaintiff’s] alleged accident was not caused by any negligent act or omission of [subcontractor], the Supreme Court properly … granted … summary judgment declaring that the [insurer] has no obligation to defend, indemnify, or provide additional insured coverage to the [general contractor] in connection with the underlying action.”

My two cents: Insureds (and sometimes other insurers) argue that endorsements that provide additional insured coverage for only vicarious liability are illusory. They argue that a general contractor cannot be held vicariously liable for its subcontractor’s acts because a general contractor, by definition, does not control its subcontractors.

• This argument ignores the reality of actual job sites in which general contractors very often dictate how, when, and where their subcontractors and their employees perform certain tasks.
• The parties’ written contracts may say one thing. Their actual conduct shows another.
• This decision from the New York appellate court is a shot in the arm for these endorsements’ enforceability.

2. ?? Opinions in Claim Notes Do Not Necessarily Create Coverage

A California appellate court held that opinions from an insurer’s claims professionals in the claim file regarding coverage may not create coverage for the claim.

Why it matters: We all know that whatever we type in claim notes could be read aloud at deposition or trial. This decision provides some limited comfort that opinions included in claim notes might not necessarily be binding on the insurer for purposes of insurance coverage.

The facts: A claimant store owner alleged that an adjacent property owner opened a Starbucks and obstructed access to the claimant’s property due to excess traffic.

• When the claimant filed suit, the liability insurer’s claims professionals felt that the lawsuit raised the potential for coverage and at least a duty to defend.
• The claims professionals included their opinions in the claim file.
• The claim file was later produced in discovery in the declaratory judgment action between the Starbucks store and its insurer.

The California appellate court rejected the notion that these opinions in the claim file admitted coverage.

• The court acknowledged that these so-called “admissions” were “actually opinions expressed by [the insurer’s] employees during confidential communications with other employees.”
• The interpretation of an insurance policy, the court said, is a legal rather than a factual determination, and thus opinion evidence is completely irrelevant to interpret an insurance contract.
• The insurer’s employees “merely expressed their opinions on the duty-to-defend issue during confidential communications with other employees.
• “If their opinions were deemed to be binding,” the court said, “free discussion among insurance company employees would be seriously impeded. An employee would be reluctant to express an opinion that the company had a duty to defend for fear that the opinion would be discoverable and would be used against the company if it decided not to defend.”
• The court ultimately decided that the policy did not provide coverage.

3. ?? Court Allocates Settlement for Coverage Despite Insurer's Refusal to Defend

A federal court in Ohio held that it would apportion the costs of a liability settlement between covered and non-covered claims before compelling the insurer to pay for the covered portion of the settlement.

Why this matters: Even though the insurer wrongfully declined to defend, the court refused to make the insurer pay the entire settlement under an estoppel theory and instead adopted an allocation rule.

The underlying claim: The insured was an engineering and construction company that built a retaining wall for a coal mine.

• The retaining wall failed.
• The coal mine sued the insured for negligent design, negligent construction, and breach of contract.
• The insurer’s professional liability policy covered losses arising from the insured’s negligence in rendering engineering services, but excluded faulty construction and workmanship.
• The insurer declined coverage for the suit.
• The coal mine and the insured then settled the claim for $3.9 million.
• They both contacted the insurer and “made clear their intention to have [the insurer] Allied World shoulder the entire settlement obligation.”
• The insurer filed a declaratory judgment action in which the federal court held that the insurer wrongfully refused to defend.

The federal court then explained the “intricate rules” under Ohio insurance law that determine whether an insurer has a duty to indemnify a settlement.

• When an insurer wrongfully refuses to defend, it cannot argue that the insured breached the policy by settling without the insurer’s consent.
• Similarly, an insurer in this situation cannot challenge the reasonableness of the settlement.
• However, an insurer’s wrongful refusal to defend does not eliminate the insured’s burden to show that the settlement falls within the policy’s coverage.
• “[A]n insurer cannot defeat an insured’s claim under the policy on the grounds that the insured struck a settlement with the third-party claimant without the insurer’s consent or that the settlement value was too costly or unreasonable. The insurer’s refusal to defend estops it from asserting those specific defenses which are inconsistent with its declining to take control over the underlying litigation. But [a prior Ohio decision] Sanderson still adhered to the baseline requirement that an insured demonstrate coverage under the policy. Or, stated differently, it did not alter the rule that an insured may not expand coverage via estoppel.”

The court then adopted an allocation rule for determining whether an insurer has a duty to indemnify a settlement under Ohio law.

• “[C]overage under the policy is still a prerequisite to recovery even for settlements executed by an insured handling his own defense in the underlying litigation. For that reason, it is no surprise that Ohio law permits allocation (i.e., the apportioning of the costs of an insured’s obligation to a third-party claimant between those claims covered by the policy and those that are not) before compelling an insurer to pay for a settlement.”
• “The parties may therefore proceed to litigate over how to apportion the costs of the settlement between covered and uncovered claims (as Allied World now maintains), which will thereby establish how much Allied World must pay for the settlement.”

Go deeper: Want to know more about the duty to indemnify? I will be joining Janet Foster, Laura Dowgin, and Heather Novison Weaver for a panel discussion on “The Duty to Indemnify and Its Impact on Liability Claim Resolution” at the ABA’s 33rd Annual TIPS ICLC Mid-Year Meeting on February 20-22, 2025, at the Estancia La Jolla Hotel & Spa in La Jolla, California. You can register for this conference at this link.

4. ?? Massachusetts Says No CGL Coverage for Construction Defects

A Massachusetts appellate court recently held that construction defects, standing alone, do not qualify as "property damage" within the meaning of a commercial general liability policy.

Why it matters: The policyholder bar has argued that recent appellate decisions across the country have shown a trend in favor of coverage for these claims. This decision certainly bucks that “trend.”

Go deeper: Homeowners sought damages from their contractor to fix several defects with the construction of their home, such as missing structural posts, incorrectly installed walls and support beams, and improper roof decking.

• The contractor’s CGL policy provided coverage for certain “property damage” caused by an “occurrence.”
• The policy defined “property damage” to mean “[p]hysical injury to tangible property, including all resulting loss of use of that property” or “[l]oss of use of tangible property that is not physically injured.”

The Massachusetts court commented that this definition suggests that “property damage” includes property that was “initially proper and injured thereafter,” not property that was “defective at the outset.”

• The appellate court continued: “Because faulty construction is defective at the outset, other jurisdictions have distinguished between claims for the costs of repairing or removing construction defects, which are not claims for property damage, and claims for the costs of repairing damage caused by construction defects, which are claims for property damage.”
• The court ultimately held that “construction defects, without more, do not constitute property damage within the meaning of a commercial general liability policy.”

Much has been made of the Illinois Supreme Court’s decision last year in Acuity v. M/I Homes concerning insurance coverage for construction defect claims.

• This Massachusetts decision shows that the debate on this issue is not over.

5. ?? Court Looks to Actual Allegations to Find No "Occurrence"

A federal court in New York applying Texas law recently held that a lawsuit against a retailer of "ghost gun" components did not meet the "occurrence" requirement of the retailer’s commercial general liability policy.

Why it matters: Even though the complaint labeled the retailer’s conduct as negligent, the court looked to the actual facts alleged in the complaint to determine that the “occurrence” or accident requirement was not met.

The lawsuit: The insured retailer sold and shipped unfinished firearms components without serial numbers or background checks that could easily be converted into completed firearms (i.e., “ghost guns”).

• The State of New York filed suit against the insured retailer alleging that these sales contributed to an increase in gun violence.

The retailer’s alleged conduct: New York alleged in its complaint that:

• “[d]espite the illegality of their conduct, each [d]efendant has intentionally and repeatedly marketed, sold, and shipped unfinished frames and receivers into New York”;
• “[d]efendants specifically market the unfinished frames and receivers as designed to evade federal gun laws”;
• “[e]ach [d]efendant intended to sell and knowingly sold unfinished frames and/or receivers to individuals who were likely to create an unreasonable risk of harm to others, such as those with criminal convictions, subject to restraining orders, with disqualifying mental health histories, or who lacked proper licensing and training”; and
• “[d]efendants here have done and continue to do nothing to geographically restrain the marketing of their prohibited products, and they employ policies and practices that result in sales of these illegal products directly to unknown and deliberately unchecked individuals in New York.”

The court rejected the insured’s argument that the complaint met the “occurrence” requirement by alleging the retailer acted negligently.

• Under Texas law, “a deliberate act, performed negligently, is an accident if the effect is not the intended or expected result; that is, the result would have been different had the deliberate act been performed correctly.”
• “Here, Defendant's uncontrolled sales were not an ‘accident’ because their effect was alleged to be fully intended and expected”.
• “The allegations in the Underlying Suits … make clear that the failure to perform any checks regarding Defendant's customers was not a mistake, but rather a deliberate part of Defendant's business and marketing model in order to maximize sales.”
• “The expected result of not implementing controls is that individuals who are prohibited from owning firearms — because their owning firearms poses an increased risk for societal harm — can obtain firearms by purchasing Defendant's products.”
• “These allegations may be presented as negligence claims, but they do not allege an accident.”

Go deeper: You can read more about this decision in this article in Law360 (with quotes from yours truly).

6. ?? No Insurer Bad Faith for “Overpaying” Settlement

A Minnesota appellate court said that an insurer did not commit bad faith by settling a liability claim for more than the insured wanted.

Why it matters: The decision reinforces the principle that most liability insurers have the right to settle claims within policy limits.

The deets: An auto liability insurer settled a bodily injury claim brought against its insured, who was father of a driver involved in the accident.

• The insured alleged that the bodily claimant “exaggerated his injuries and losses to obtain financial gain.”
• The insured also accused the insurer of failing to investigate the claim and ignoring evidence that suggested he was not liable.

The court’s holding: The appellate court concluded that the insurer did not commit bad faith.

• Minnesota law requires liability insurers to investigate claims, such as to fulfill an insurer’s settlement obligations and protect its insured.
• However, the court commented that “no cases … require an insurer to investigate to minimize the amount the insurer itself pays to resolve a claim.”
• “While our cases leave room for an insurer to seek a lower settlement payment in appropriate circumstances, they do not require it,” the court said.

Not the only one: California courts have similarly rejected bad faith claims when an insurer “overpays” to settle due to an inadequate investigation, even where the settlement negatively impacts the insured's future insurability or premiums.

7. ?? Declination After ROR Was Appropriate

A federal court in Washington said that an insurer did not commit bad faith by defending the insured under reservation of rights and then declining coverage after determining that a policy exclusion applied.

Why it matters: Insurers are often wary of withdrawing a previously provided defense under reservation of rights for fear of bad faith. This decision, by a court in a challenging jurisdiction for insurers, approved of the insurer doing so.

Some background: A subcontractor’s employee filed suit against the general contractor N.W. Classic for bodily injuries the employee sustained constructing a stormwater detention vault for a new residential subdivision.

• The subcontractor’s insurer Evanston Insurance Company issued N.W. Classic a letter in December 2020 that said the insurer would “participate in the defense of N.W. Classic subject to the reservation of rights.”
• One of the coverage defenses listed in the ROR letter was whether the construction project was related to residential construction, which would have been excluded under Evanston’s policy.
• The letter stated: “Evanston will be conducting an investigation to determine whether the housing development upon which [plaintiff] was working at the time of the accident qualifies as ‘residential construction.’ If Evanston determines that the housing development upon which Flores was working was ‘residential construction’ and necessarily falls within the scope of an exclusion in the Policy, then Evanston will file a declaratory judgment action to determine its rights and obligations under the Policy and to withdraw from its participation in the defense of N.W. Classic, if appropriate.”
• Evanston sent N.W. Classic a letter in June 2022 that it had completed its investigation, determined that the residential exclusion applied, and would file a declaratory judgment action.

No bad faith: The court held that the exclusion applied and that Evanston did not commit bad faith.

• “The initial offer to defend under a reservation of rights, followed by an investigation and the subsequent determination that an exclusion applies, is acceptable industry practice. Evanston's interpretation of its policy was reasonable. The Court has already found that this exclusion applies. The Court also finds that the undisputed facts do not support any claims against Evanston for insurance bad faith.”

Go deeper: Want to know more about bad faith? I will be joining Kevin Willging for a presentation on “Emerging Issues in Third Party Bad Faith Claims” at PLRB’s 2025 Claims Conference & Insurance Services Expo on March 31 - April 2, 2025, in Indianapolis, Indiana. You can learn more about the conference here.

8. ?? Court Orders Internal Claim Documents Turned Over

A federal court in Vermont held that materials prepared by an underinsured motorist (UIM) carrier after it received a settlement demand but before it responded to that demand were not protected from disclosure by the work product doctrine.

Why it matters: The decision provides another example of how an insurer’s internal documentation of a claim could very well be subject to discovery in later litigation over that claim.

The backstory: Two claimants made a UIM claim for injuries sustained in an auto accident.

• The claimants demanded payment of the policy’s $1 million UIM limit.
• The UIM insurer made a counter-offer of $10,000, and later raised its offer to $15,000.
• The claimants filed suit and requested in discovery, among other things, the insurer’s Bodily Injury Settlement Evaluation Tool, its File Summary Analysis, and its Loss Analysis Report.
• The insurer created these items after the claimants made their settlement demand but before the insurer responded with its counteroffer.

The ruling: The federal court held that these materials did not fall within the work product doctrine— which protects discovery of “documents … prepared in anticipation of litigation”—and ordered their production.

• The court acknowledged that the “issue of work-product protection is particularly complicated in the context of insurance claims, since insurance companies are ‘in the business of investigating and adjusting claims,’ thereby blurring the distinction between documents prepared in the ordinary course of business and those prepared because of anticipated litigation.”
• The court also commented that in the insurance context, “courts frequently presume that investigative reports prepared by or for an insurer prior to a coverage decision are prepared in the ordinary course of the insurer’s business and are not afforded work-product protection.”
• Because the only evidence of a coverage decision was the insurer’s counteroffer, the court held that materials prepared before that counteroffer was made were discoverable.
• Although the insurer submitted evidence from its claims representative attesting to the “substantial threat of litigation” after the insurer received the claimants’ settlement demand, the court said “the threat of litigation … is not the same as a resolve to litigate.”

But wait: The court noted that the retention of counsel may also indicate the anticipation of litigation, but the insurer here did not retain counsel until several months after it made its counteroffer.

Coverage Review is written by Michael L. Young, an award-winning litigation partner at Reichardt, Noce & Young LLC in St. Louis, Missouri. For over twenty years, Michael has focused his practice on insurance coverage and extra-contractual matters and currently represents insurer clients in Missouri and Illinois. He also serves as Adjunct Faculty at Saint Louis University School of Law and teaches a course in Insurance Law. Be sure to check out his popular insurance podcast Tales From Insurance Land.