Delaware Chancery Court Opens the Door to "All Sums" Allocation in New York

On October 14th, Vice Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery blew some much needed fresh air into New York allocation jurisprudence. The Viking Pump consolidated cases, C.A. 1465-VCS, have already yielded very interesting and thoughtful rulings on the transfer of insurance in connection with complicated corporate transactions. Viking Pump, Inc. v. Liberty Mutual Insurance Company and Warren Pumps LLC, 2007 WL 2752912 (Del. Ch. Apr. 2, 2007 (unpublished opinion).

The latest decision, the first nearly fifty pages of which is also devoted to corporate transaction issues, then spends the next 40 pages [yes, it is 88 pages long] delving into the arcana of allocation law. 

 

Viking Pump and another formerly related entity, Warren Pumps, are on the receiving end of asbestos personal injury claims. The policies that cover these entities were issued to their former parent, Houdaille Industries, formerly headquartered in New York. The primary and first layer umbrella policies, sold by Liberty Mutual were exhausted, thus, the issue before the court was allocation of liability for the asbestos claims among the excess insurance companies. The excess argued that under controlling New York precedent – Con Edison v. Allstate Ins. Co., 774 N.E.2d 208 (NY 2002) – there must be a pro rata allocation. 

After pointing out that New York had not taken a public policy position on allocation (unlike, for example, New Jersey) but instead looks to the policy language, the court nodded to the Court of Appeals reliance on the “during the policy period” phrase in its Con Ed decision and took a swipe at the Second Circuit’s approach in Olin. Because of New York’s policy language-centered approach to allocation, Vice Chancellor Strine wrote: “the fact that one decision held that a particular policy embraced the pro rata approach does not make New York a ‘pro rata state.’” [p. 68]

The court then turned to the impact of non-cumulation and prior insurance clauses that appear in many excess policies. The non-cumulation clauses appeared in the Houdaille excess program courtesy of follow-form endorsements; the excess policies following to Liberty Mutual forms. Liberty Mutual, thanks to Gilbert Bean, was the only insurance company to come to grips with the consequences of gradual injury claims under the new “occurrence” form in 1966-67. Liberty incorporated either “deemer” or “non-cumulation” clauses into nearly all of its policies in order to prevent “stacking of limits.  

The court found that these non-cumulation and prior insurance clauses “unambiguously provide for all sums allocation.” [p. 68] and “cannot sensibly be applied within a pro rata allocation scheme.” [p. 71]. In this, the court was not breaking new ground. See Spaulding Composites (NJ), Outboard Marine (IL), Dow Corning (MI), Liberty Mutual (PA), and Hercules (DE).

Helpfully, the insurance companies could not agree amongst themselves how to sensibly marry pro rata allocation relying on “during the policy period” with their non-cumulation and prior insurance clauses (footnote 170 is illuminating). Vice Chancellor Strine concludes with brio:

It is a fundamental New York rule of contract interpretation that a court should read a contract in order to give full effect to every term therein.  The Excess Insurers would have me interpret the Houdaille Policies as embracing the pro rata method of allocation by having me jettison explicitly bargained-for provisions of those Policies that benefit them, and therefore reconciling the evident conflict between explicit provisions of the Policies and the pro rata method the Excess Insurers say is implicitly called for by the Policies. In other words, the Excess Insurers would have me elevate their self-interested policy preference over the only method of allocation that permits the sensible operation of all of the Houdaille Policies’ material terms. New York law does not permit such a result but instead requires giving effect to the parties’ contractual choice.

            ***

Most important, the contractual language only works if all sums is the approach. The Excess Insurers bargained for an all sums method of allocation greatly tempered by exposure-reducing Non-Cumulation and Prior Insurance Provisions. They cannot now prospect for more by having a court substitute a different allocation method for that which best fits with all of the terms of the relevant Policies.

Id. at 80-81.

Stay tuned for the New York courts’ reaction to Vice Chancellor Strine.

Third Circuit Misses the Mark in CPB International

This post was written by Douglas R. Widin.

Recently, the Court of Appeals for the Third Circuit decided Nationwide Mutual Insurance v. CPB International, Docket No. 07-4772 (April 14, 2009). CPB supplied chondroitin to Rexall for use in compounding tablets, including chondroitin and glucosamine. CPB supplied two batches of chondroitin that turned out to fall short of contractual specifications and to contain impurities. By the time these defects were discovered, Rexall had already compounded the CPB-supplied material with glucosamine, so that both compounds had become useless.

In the lawsuit that ensued, Rexall brought a claim for breach of contract against CPB seeking return of the purchase price it had paid for the first batch, and also seeking consequential damages for the damage to the glucosamine and economic losses. CPB tendered that claim to its CGL carrier, Nationwide, which defended under a reservation of rights and also brought a declaratory judgment action to avoid any duty to defend or indemnify.

The Third Circuit held in favor of Nationwide and discharged it from any coverage obligations.

The court first observed that the matter clearly involved a claim of property damage, so it didn’t focus on that issue. It then examined the claim made by Rexall against CPB and concluded it was solely based on breach of contract. Turning to the crux of the coverage issues, the Third Circuit, premised on the Pennsylvania Supreme Court's decision in the Kvaerner case [Kvaerner Metals Div. of Kvaerner US, Inc. v. Commercial Union Ins., 908 A.2d 888 (PA 2006) determined that the simple allegation of delivery by CPB of defective chondroitin was an allegation of faulty workmanship that is not covered by the CGL policy. The Third Circuit went further than Kvaerner, however, deciding that, since faulty workmanship is not sufficiently fortuitous to be an accident or an occurrence, the consequential damages flowing from the faulty workmanship, being the foreseeable consequences of that faulty workmanship, are also not an accident or an occurrence. Therefore, the court held that the consequential damages were also not covered. In conclusion, the Third Circuit wrote, "We are, therefore, confident that the Supreme Court of Pennsylvania would conclude that an underlying claim alleging breach of contract would not trigger coverage under a CGL policy."

Adding insult to injury, the court held as an alternative ground for denial of the claim that the contractual liability-exclusion of the policy applied. The policy at issue contained a standard contractual liability-exclusion stating that the "insurance does not apply to … ‘property damage’ for which the insured is obligated to pay by reason of the assumption of liability in a contract or agreement." We have all seen this exclusion in various forms many times. We all recognize that it is designed, as is often stated expressly, to apply to a situation where the insured assumes the tort liability of another in a contract, such as by giving an indemnity. The Third Circuit did not consider this reading of the exclusion at all. This leads to the most disturbing element of this case, which is that the court did not even consider the potential alternative reading of this exclusion, such that it is interpreted as only applying to assumption of a third party's liability. Instead, the court effectively turned the normal rules of insurance policy construction—ambiguities are construed against the insurer as drafter—on their head and gave the insurer the benefit of an inherently ambiguous policy provision.

Although the Third Circuit's decision is unquestionably flawed, denials of coverage by insurance companies for consequential damages based on this case can be anticipated. Policyholders faced with this should point out to their carriers that the CPB case is limited to purely contract-based claims, so any suit involving a tort claim should be analyzed differently. 

Even more disturbing, the CPB case may well be invoked by first-party insurers by applying and interpreting faulty workmanship exclusions in a much broader sense in first-party claims. Finally, carriers will likely be pushing the limits of their contractual liability exclusions, even when based on more traditional phrasings than the one found in CPB, to try to preclude claims wherever there is a contract involved that forms any basis of the allegations of liability on the part of the insured. It is hoped that in the not too distant future, a case will come up in the Pennsylvania state court system that will provide the Pennsylvania Supreme Court with the chance to correct some of the Third Circuit's mistakes. Until then, however, policyholders will need to contend with the unfortunate and flawed decision in CPB.