Representations and warranties insurance: I have a breach; what’s next?

When acquiring another entity, many companies purchase representations and warranties (R&W) insurance to cover losses due to breaches of representations and warranties in purchase agreements. These R&W policies may apply in excess of a seller indemnity or, if the acquired entity has been resold, there may be separate lines of coverage for multiple acquisition agreements that apply to one breach. So, what happens after the deal closes and the purchaser discovers a breach?

  •  R&W policies cover both first-party and third-party claims

First-party claims involve issues that are discovered by the buyer after the closing that result in losses. Examples of such breaches include:
• An audit of a company’s records revealing financial or reporting issues.
• The company’s manufacturing equipment not performing to the standards warranted.
• Relations with customers not being as warranted or the buyer discovering breaches of contracts.

Third-party claims arise when a third party makes a demand or files suit against the company. For example, after closing, the company is served with a customer complaint alleging breach of contract and inference with business relations. A review of the company’s files indicates that prior to the sale, the sellers had been notified by the customer of its potential claim but did not disclose it to the buyer. This may be a breach of representations regarding contracts and litigation or claims. Another example of a third-party claim is a government civil or criminal investigation into the company.

Best practices: After a deal closes, calendar any dates for releases of escrows or limitations periods. Have periodic check-ins, three to six months prior to the calendared date, to determine whether there are any breaches that may result in a covered loss.

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New York’s exception allowing attorney’s fees for policyholders

An often-overlooked 2020 New York federal court decision allows policyholders to potentially recover attorneys’ fees when they bring a declaratory judgment action against an insurance company that has made litigation inevitable by resisting its duty to defend. In Houston Casualty Company v. Prosight Specialty Insurance Company, 462 F. Supp. 3d 443, 444 (S.D.N.Y. 2020), the District Court for the Southern District of New York held that an insurance company’s duty to defend obliges it to pay for attorneys’ fees and costs that an additional insured incurred in attempting to establish the duty to defend at the time the insurance company resisted such a duty.

The Houston Casualty Company case concerned an underlying lawsuit brought against New York University Hospitals Center (NYUHC) by an individual who was injured on its premises. The individual was injured due to a mis-leveled elevator maintained by a New York corporation, Nouveau. NYUHC brought a third-party complaint against Nouveau, as it had agreed to hold NYUHC harmless for any claims or liabilities arising out of the maintenance and repair of elevators on NYUHC’s property.

Houston Casualty Company (HCC) issued a general liability policy to the injured individual’s employer and HCC provided a defense to NYUHC and the construction company on the site, but HCC asserted that the primary obligation to defend these lawsuits belonged to Nouveau’s general liability insurance company, New York Marine (Note: New York Marine was named incorrectly by the plaintiff, HCC, as Prosight in the case). HCC sought declaratory judgments as to NYUHC’s additional insured status; New York Marine’s duty to defend and indemnify NYUHC; and HCC’s entitlement to reimbursement for all amounts paid by HCC, including attorneys’ fees, for the defense of the underlying action. These questions were resolved by agreement of the parties, and New York Marine conceded it had a duty to defend. However, the district court considered one unresolved issue regarding “whether NYUHC is entitled to recover, from New York Marine, the fees and expenses it incurred in attempting, successfully, to establish New York Marine’s duty to defend NYUHC in the consolidated [underlying] lawsuits.” Id. at 449.

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Year in review: Reed Smith’s Insurance Recovery team highlights top insurance topics of 2021

At Reed Smith, we pride ourselves on forming true partnerships with our clients to find creative and unexpected solutions to the most challenging insurance coverage issues. As part of this commitment, we have authored a column for Thomson Reuters to provide advice, strategies, and information on the full range of insurance coverage issues affecting commercial policyholders. Below is a year-end roundup of the column articles published in 2021.

The appeal of COVID-19 business interruption appeals

As we continue to navigate through the pandemic, business interruption suits and court rulings continue to progress. Our Insurance Recovery team highlights a few of the top COVID-19 business interruption cases on appeal.

’Tis the season for fires and hurricanes: avoiding insurance coverage pitfalls

In the United States in 2020, wildfire damages accounted for more than $16 billion and hurricane damages accounted for an estimated $37 billion. Reed Smith provides a multitude of tips on avoiding common property insurance coverage pitfalls.

Blank-check boom: D&O insurance strategies for SPAC management

Reed Smith’s Insurance Recovery team details how the rise in litigation involving special purpose acquisition companies (SPACs) and the increased regulatory scrutiny of SPACs calls for more focus on D&O coverage for SPAC management.

Don’t make the cure worse than the disease: tips for securing prompt insurance recovery of ransomware losses

Cyberliability insurance often covers ransom payments in ransomware attacks. But in many cases, ransom payments and their associated costs are just the tip of the iceberg. Even those companies fortunate enough to avoid paying a ransom will still incur other substantial costs. Reed Smith offers strategies to quickly and successfully secure insurance coverage for losses arising out of ever-increasing ransomware attacks.

Labels, Shmabels: Recent Decisions Confirm No “Restitution / Disgorgement” Exclusion in Management Liability Policies

Ever since the Seventh Circuit’s 2001 decision in Level 3 Communications, Inc. v. Federal Insurance Co., 272 F.3d 908 (7th Cir. 2001), insurance companies have argued that settlements constituting restitution or disgorgement are uninsurable on grounds of public policy. While numerous decisions since 2001 have undercut this defense, two recent decisions out of the New York Court of Appeals and the Northern District of Illinois further confirm that coverage does not depend on how the damages paid are characterized. In both J.P. Morgan Securities Inc. v. Vigilant Insurance Co., No. 61, 2021 N.Y. slip op. 06528 (N.Y. Nov. 23, 2021), and Astellas v. Starr Indemnity, No. 17-cv-8220 (N.D. Ill. Oct. 8, 2021), the courts looked beyond the labels of “restitution” and “disgorgement” affixed to the insureds’ settlement payments to determine whether such payments were covered by each insureds’ respective insurance policies.

Last week’s post on The Policyholder Perspective took an in-depth look at Vigilant Insurance Co.  This week we consider how Vigilant, in tandem with Astellas, demonstrates a trend in how courts interpret labels on payments in an insured’s settlement agreement.

In Astellas, the insured (Astellas) entered a settlement agreement relating to a False Claims Act investigation and agreed to pay $100 million plus interest to the United States, with $50 million of such settlement labeled as “restitution to the United States.” In a similar vein, the insured (Bear Sterns) in Vigilant Insurance Co. entered a settlement agreement with the SEC for alleged illegal trading practices and made a $160 million “disgorgement” payment – $140 million of which was an estimate of the profits gained by Bear Sterns’ clients – and a $90 million payment for “civil money penalties.” Astellas submitted a claim to its insurers for the $50 million “restitution to the United States,” and Bear Sterns submitted a claim for the $140 million “disgorgement” payment reflecting its clients’ profits gained.

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End to long-running dispute over uninsurability under D&O insurance

Putting an end to a 12-year-old dispute between J.P. Morgan Securities’ predecessor, Bear Stearns & Co., and several of its insurers, on November 23, 2021, New York’s high court held that J.P. Morgan’s $140 million payment to the Securities and Exchange Commission (SEC) did not constitute an uninsurable “penalty” under J.P. Morgan’s excess directors & officers (D&O) liability policies. This is welcome news for policyholders faced with coverage denials from their insurers based on “public policy,” “fines or penalty,” “disgorgement” or other grounds of alleged uninsurability.

In J.P. Morgan, J.P. Morgan’s $140 million “disgorgement” payment was part of a larger $250 million settlement between J.P. Morgan and the SEC. $90 million of the settlement was specifically allocated to “civil money penalties.” The settlement resolved allegations that Bear Stearns & Co. and other securities broker-dealers facilitated late trading and deceptive market timing practices by their customers in connection with the purchase and sale of mutual funds.

J.P. Morgan’s excess policies covered “loss” that the insured entities became liable to pay as the result of any civil proceeding or governmental investigation alleging wrongful acts constituting violations of laws or regulations. The policies defined “loss” to include various types of compensatory and punitive damages where “insurable by law,” but specifically excluded matters uninsurable as a matter of public policy and “fines or penalties imposed by law.” The insurers argued that the disgorgement payment was uninsurable as a matter of New York law both as form of restitution of ill-gotten gains and as a penalty imposed by law.

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Employment-related practices exclusions and Biometric Information Privacy Act litigation

In West Bend Mutual Insurance Co. v. Krishna Schaumburg Tan, Inc., 2021 IL 125978, the Supreme Court of Illinois held that coverage existed for a class action alleging violations of the Illinois Biometric Information Privacy Act (BIPA) under the terms of a general liability policy. Although a win for the policyholder bar, the precedential value of Krishna was arguably limited by the fact that the underlying class action targeted the insured’s use of customer biometrics. Where the use of employee biometrics is at issue instead, policyholders are likely to face unique coverage issues left open by Krishna, such as the applicability of certain exclusions that bar coverage for injuries arising out of the employment relationship. This blog post provides a brief overview of the employment-related practices (ERP) exclusion and explains why it should not apply to preclude coverage for employment-based BIPA class actions.

Employment-related practices exclusions

The ERP exclusion is a common provision in commercial general liability policies. As it is usually drafted, the exclusion bars coverage for bodily injury or personal and advertising injury to a person arising out of any of the following:

  • Refusal to employ that person
  • Termination of that person’s employment
  • Employment-related practices, policies, acts or omissions, such as coercion, demotion, evaluation, reassignment, discipline, defamation, harassment, humiliation, or discrimination directed at that person

In coverage disputes arising out of employment-based BIPA class actions, the issue will be whether the conduct at issue is an employment-related practice that falls within the third prong of the exclusion.

Case law analyzing employment-related practices exclusions

Several courts that have analyzed the scope of the ERP exclusion have concluded that it should be interpreted narrowly. For instance, in Peterborough Oil Co. v. Great American Insurance Co., after the insured fired an employee for theft and pressed charges, the employee sued the insured for malicious prosecution and intentional infliction of emotional distress. 397 F. Supp. 2d 230, 234 (D. Mass. 2005). The insured tendered the lawsuit under its commercial general liability policy, and the insurer denied coverage in reliance on the policy’s ERP exclusion. Id. at 235. The insured filed a coverage action and argued that the exclusion did not apply. Id.

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Insurance companies in run-off

What is an insurance company “in run-off”?

An insurance company is considered to be in run-off when it ceases selling new insurance policies. The essential business of an insurance company is risk pooling. Insurance companies evaluate risks, price and sell insurance policies that assume risks, and pay claims to policyholders that suffer losses covered by the insurance. Insurance companies generate revenue to pay claims principally from two sources: premiums and investment income. Insurance companies also typically buy insurance to insure the risks they have assumed – called reinsurance – which acts as a secondary risk pool. When an insurance company enters run-off, it loses the benefit of ongoing premiums as a source of income to pay claims. The only sources of income become investment earnings, sales of assets, and potential recovery from reinsurance.

What does run-off mean for the policyholder?

Being in run-off does not absolve an insurance company of its duties under policies it has already sold. The contractual relationships between the insurance company and its policyholders do not end. The insurance company still owes to its policyholders the full complement of duties that the policyholder purchased with its premiums. Most important, the insurance company must pay claims as they come due under the policies.

While entering run-off cannot rewrite the terms of existing insurance policies, in practice, many policyholders encounter unexpected challenges from an insurance company in run-off. Because the insurance company is no longer writing new business, its claims-handling protocol may not prioritize customer service as an active company, seeking to maintain its customers, might. In many circumstances, the insurance company may contract with a professional run-off administrator to handle claims. While, again, a run-off insurance company and its agents are subject to the same duties to policyholders as existed before the run-off, from the policyholder’s perspective, the quality of claims handling is often diminished.

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Music to my ears: Coverage considerations for musical instrument insurance (Part II of II)

Part II: exclusions, considerations, filing a claim, and tips

This is the second part of a two-part blog series titled, “Music to my ears: Insurance coverage for musical instruments”. Part I covers policy options.

Professional and amateur musicians alike can purchase insurance to cover their instruments.

Musical instrument policies are subject to exclusions and requirements, which may vary. Requirements under the policy are another important component.

Exclusions

Some common exclusions in musical instrument coverage include:

  • Wear and tear, inherent defect, deterioration, and vermin damage.
  • Breakage of strings, reeds, or drumheads while the instrument is being played.
  • Neglect, such as the failure to maintain or properly store the instrument.
  • Loss or damage during maintenance, repair, or restoration.
  • Humidity, aridity, or temperature extremes (unless caused by storm or fire); condensation; dampness; frost; dust; effects of sunlight; fading; and changes in color, texture, or finish.
  • The cost to obtain an estimate or quote to replace or repair the musical instrument.
  • Damage or loss while the instrument is in an unattended vehicle (though cover may be obtained, sometimes limited by the night-time clause, excluding coverage for loss or damage of instruments left in a car between 10 p.m. and 6 a.m. There may be no coverage without forced entry).
  • Transit by air, postal, or other delivery transit.
  • Costs as a result of being unable to use the musical instrument (which may be covered by business income loss coverage under a commercial policy).
  • Unexplained disappearance.
  • Intentional damage.
  • Damage due to pollutants.
  • Governmental or military action, war, and terrorism (though cover for terrorism may be purchased from some carriers as an endorsement for an additional premium).
  • Nuclear hazard.

Some exclusions may include anti-concurrent causation language, precluding coverage when the excluded cause of loss is involved, whether there are other causes or not. In particular, the nuclear hazard, war and military action, and pollution coverages may be excluded regardless of whether any other covered cause of loss is also present.

Other considerations

  • Valuation issues

Insurance carriers providing agreed value coverage require an appraisal for valuation purposes when they issue and/or renew a policy. Appraisals should be reviewed at renewal time, and they should be updated at least every three years. If the instrument is extremely rare, insurers may request their own appraiser prior to issuing coverage.

The value of the insured instruments may be determined at the time of loss or damage, even though an appraisal was required at the time of placement. The insurer may force the insured into arbitration or litigation regarding valuation. If your instrument is more than three years old, the policy should include new for old cover so you can get full replacement value.

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Music to my ears: Coverage considerations for musical instrument insurance (Part I of II)

Part I: Policy options

This is the first part of a two-part blog series titled, “Music to my ears: Insurance coverage for musical instruments”. Part II covers exclusions, considerations, filing a claim, and tips.

Musical instruments can cost significant sums running from a few hundred or thousand dollars to a million dollars or more. And that is to say nothing of the special bond musicians have with their instruments (the authors are both amateur musicians, and when the violist even thinks her viola has been bumped while in its case, she feels as though her own person has suffered injury). Professional and amateur musicians, as well as collectors of highly valued or rare instruments, may require or desire insurance to protect their instruments from loss or damage.

Instrument insurance covers the instrument, and usually covers accessories like bows, sheet music, cases, bags, and stands, unless specifically excluded. High-value accessories should be individually listed on the policy.

Musicians may need coverage if the instrument is used routinely for performances or teaching, or if it travels to school, work, lessons, rehearsals, or concerts. Collectors with expensive and rare instruments may want coverage. Professional musicians may need a commercial musical instrument policy (discussed below) to limit the time they spend without their instrument if it needs repair, if they need to rent a temporary instrument while repairs are made or if they need to purchase a new instrument.

Musical instrument coverage can be customized, with policyholders choosing the amount of coverage they need and the amount of the deductible. Musical instrument carriers, which may be specialty insurers, frequently divide instruments into categories, and coverage may also include electronic instruments, recording equipment, and electronic gear.

Some policies have a maximum amount they will insure per instrument. Commercial musical instrument policies provide several valuation options, such as payment for a claim based on an agreed-upon value determined when the policy is placed, the instrument’s value, or its replacement value at the time of loss.

Coverage counsel can assist with placement, review, and renewal for musicians, collectors, and ensembles, and if valuation or coverage disputes arise in the event the unthinkable occurs.

Musical instrument coverage for amateur musicians

Amateur musicians are those who play a musical instrument (or several), but who do not receive compensation for playing the instrument, including people learning to play an instrument, and those who play as a hobby alone or in a group. A musician who makes any income from his or her playing is not an amateur for coverage purposes and may require business insurance.

Some homeowner’s or renter’s policies cover musical instruments, but they are subject to some limitations. Frequently, they contain limits for the home’s total property damage and may have applicable per-item limits or sub-limits for musical instruments, which may be lower than the musical instrument’s value. Many only cover damages occurring while the instrument is in the covered residence. Even when there is off-premises coverage, that amount is limited to 10 percent of the policy’s dwelling coverage limit, which may not cover the loss. Homeowner’s and renter’s policies only cover damage from “named perils” such as fire and theft, but not for unnamed perils. Typically, such policies only provide actual cost value, so it can be difficult to receive compensation for the instrument’s replacement value.

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Five COVID-19 business interruption appeals to keep an eye on

More than a year has passed since COVID-19 first plagued the United States and impinged on the health of more than 34 million Americans. Hundreds of thousands of businesses have shuttered due to the pandemic. Policyholders have relied, and will continue to rely on their business interruption insurance policies to respond to their pandemic-related losses. In these unprecedented times, trillions are at stake with many policyholders calling on the courts to protect their rights.

Reed Smith’s Insurance Recovery Group recently launched a Thomas Reuters column covering cutting-edge topics in insurance from the policyholder perspective. The first column article titled “The appeal of COVID-19 business interruption appeals” discusses the current appellate landscape of COVID-19 business interruption cases.

Brief overview of appellate landscape

The only appellate court that has issued a ruling is the 8th U.S. Circuit Court of Appeals in Oral Surgeons v. Cincinnati Insurance. There, the 8th Circuit affirmed the Iowa district court’s decision to dismiss the insured’s complaint, reasoning that dismissal was warranted where the policy required direct “accidental physical loss or accidental physical damage” and the complaint did not allege any physical alteration of property. The complaint, rather, only pled “generally that Oral Surgeons suspended non-emergency procedures due to the COVID-19 pandemic and the related government-imposed restrictions.” Given the particular policy language, allegations of that complaint, and lack of a “physical alteration” requirement under the law of most states, the decision is not expected to have a significant impact (if any) on pending appeals.

Appeals remain pending in California, District of Columbia, Florida, Illinois, Indiana, Massachusetts, Michigan, New Jersey, New York, Ohio, Oklahoma, Pennsylvania and Wisconsin. No state appellate court has yet rendered a decision.

The article flags five pending appeals for policyholders to keep an eye on, as they will likely shape the future of the law surrounding insurance coverage for COVID-19 business interruption losses. Continue Reading

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