In the bellwether case of Joseph Tambellini, Inc. v. Erie Insurance Exchange, the Pennsylvania Supreme Court was petitioned under its King’s Bench powers to assume plenary jurisdiction of an insurance coverage dispute that had been filed in the Court of Common Pleas, Allegheny County, Pennsylvania. The high court was asked to decide critical legal issues that would have impacted thousands of other insurance claims that might arise in the future from the COVID-19 pandemic. Duane Morris was retained by insurer trade associations, including APCIA, NAMIC, PAMIC, and the Insurance Federation of Pennsylvania (the “Insurance Industry Amici”), to oppose this extraordinary petition. Continue reading Duane Morris Helps Insurance Industry to a Major Win on COVID Losses for Business Interruption Before the Pennsylvania Supreme Court
We previously wrote about the growing number of lawsuits by insureds seeking business interruption insurance coverage for business losses in response to the novel coronavirus (here and here), and the constraints that state and federal governments should face were they to compel such coverage. We also previously detailed nationwide efforts aimed at enacting legislation compelling business interruption and contingent business interruption insurance for COVID-19 losses.
As of the date of this update, eight states have proposed a number of bills relating to business interruption insurance. Continue reading An Update on Congressional Efforts to Compel Coronavirus Business Interruption Insurance
By Damon N. Vocke and Mark A. Bradford
As if COVID-19’s initial challenges related to claims, renewals, and exclusions, all while operating in a remote environment, were not enough, ceding and assuming companies face risk associated with their counterparties’ ability to survive the proverbial economic storm. This risk will only be heightened if other severe events develop in the near term including CAT losses or cyber occurrences. As business moves forward from and through the pandemic, insurance and reinsurance professionals need to pay attention to the solvency of counterparties, including captives and fronting carriers, in light of the stress that COVID-19 will impose on claims and investment portfolios.
Doing business with a counterparty operating in or near the zone of insolvency can unwittingly create risk, especially because the amounts associated with an insurance insolvency are often significant. E.g. Jo Ann Howard & Assocs., P.C. v. Cassity, 395 F. Supp. 3 1022, 1194 (E.D. Mo. 2019) (entering $102 million judgment in favor of receiver of insolvent insurance company following four week bench trial which followed appellate reversal of prior jury trial that had resulted in $390 million verdict in favor of receiver). In one instance, an insurer or reinsurer may face claims that it precipitated an insolvency as a result of not having timely honored claims. While in another, insurers and reinsurers, alike, may face accusations of disguised insolvency to perpetuate a counterparty and thereby further the solvent company’s own business interest to the detriment of the insolvent company’s creditors.
The term “zone of insolvency” is somewhat amorphous, and leading courts have struggled with a precise definition. Generally speaking, the term means a distressed company with a deteriorating fiscal condition, minimal reserves, marginal surplus, and little ability to invest in future operations. Think of a company who might not be able to obtain a loan from a commercial lender or a company whose reserves and financial position might cause a regulator heartburn during an examination. While insolvent counterparties are not easy to spot, and there is often at least some plausible deniability, claims and account executives may hear stories from their counterparts or senior personnel may have learned that a counterparty has taken a large hit or is fighting a bet the company series of claims.
Beyond claims that a transaction or course of conduct caused or disguised an insolvency, struggling companies create risk to the extent that state insurance codes and federal bankruptcy law allow receivers and trustee to void payments made within a certain time period, typically three months to a year depending upon the jurisdiction, preceding an order of liquidation or rehabilitation. Receivers sometimes have years to initiate proceedings to claw back payments such that a company who thought its books were settled could face claims down the road. Creditors similarly may have claims under state law to claw back payments. E.g. Gen. Fidelity Ins. Co. v. WFT, Inc., 837 S.E.2d 551, 556-57 (N.C. Ct. App. 2020) (affirming judgment in favor of creditor of dissolved company). If a counterparty transfers its assets, dissolves, or is placed into receivership, it makes sense to immediately evaluate what claims may be brought against the insolvent counterparty and how to make claims against the insolvent estate in any state receivership or federal bankruptcy proceedings, in the event one is opened, in addition to considering defensive posture.
Third-party liability claims can ensnare.
Aiding and abetting is a powerful and often utilized tool in a receiver’s, bankruptcy trustees’, or creditor’s kit. Counterparties, including reinsurers, and professional advisors such as actuaries, attorneys, accountants and consultants are prime targets for third-party liability claims even if their conduct or advice was not the reason for the insolvency. E.g. Stewart v. Wilmington Trust SP Servs., Inc., 112 A.3d 217, 320-21 (Del. Ch. 2015) (sustaining certain aiding and abetting claims brought by liquidator of captive insurer while dismissing others), aff’d 2015 WL 6672222 (Del. 2015). Liquidators and creditors may bring claims, either in concert or in competition with one another, targeting the going concerns who have the ability through their own funds or insurance coverage to satisfy a judgment.
Choice of law matters.
Some jurisdictions limit the duties owed to creditors or at least restrict direct claims, as opposed to derivative actions, by creditors. E.g., North Am. Catholic Educ. Programming Found., Inc. v. Gheewalla, 930 A.2d 92, 101-02 (Del. 2007) (holding creditors could not assert direct action). However, other jurisdictions impose obligations before the moment of insolvency when the company was operating in the ill-defined and difficult to pinpoint “zone of insolvency”. For example, Vermont, which is one of the leading domiciles for captives with over 575 active captives and over $22 billion in annual gross written premium, imposes a duty to creditors “not only when the corporation is technically insolvent, but also when the corporation operates in the vicinity or zone of insolvency.” Gladstone v. Stuart Cinemas, Inc., 178 Vt. 104, 117 (Vt. 2005).
A counterparty may be domiciled in a jurisdiction other than where its personnel are located. It is a good idea to take stock of counterparties’ domiciles and form of organization, e.g. stock company, mutual, reciprocal, etc., including those operating domestic or foreign captives, and if necessary, to engage counsel to evaluate what duties may be owed and to whom.
Insolvency Can Create Competing Claims and Extended Statutes of Limitations.
Generally speaking, insurance companies are excluded from federal bankruptcy and are rehabilitated or liquidated under the auspice of state receivership statutes. This can create a patchwork of potential laws and competing liquidating authorities each laying claim to assets or claims. For example, an insolvent counterparty may have as its parent a non-insurance holding company, or in the case of a captive a non-insurance insured, who would be liquidated under the bankruptcy code and one or more operating entities that write insurance or reinsurance and that would each be subject to liquidation in their state of domicile. In re First Assured Warranty Corp., 383 B.R. 502, 521 (Bankr. D. Colo. 2008) (holding that bankruptcy court had jurisdiction over non-insurance affiliate) (“domestic insurance companies are ineligible for bankruptcy relief.”) In these types of competing claimant situations, it is important to observe contractual formalities and obtain releases from all potentially interested parties if possible. See Stephens v. Nat’l Distillers & Chem. Corp., 70 F.3d 10, 12 (2d Cir. 1995) (vacating and remanding for additional proceedings regarding claim by liquidator of reinsurer against non-insurance holding company for return of dividend payments).
Receivership can also extend the time in which a counterparty’s liquidator can assert claims. Fla. Stat. §631.042 (tolling and extending statute of limitations as to claims by receiver of insolvent insurance company); In re Diamond Benefits Life Ins. Co., 907 P.2d 63, 67 (Ariz. 1995) (holding that insurance receiver pursuing claim for conversion of company funds was exempt from statute of limitations). It may also allow a receiver to void arbitration and forum selection provisions. Taylor v. Ernst & Young, L.L.P., 958 N.E.2d 1203, 1211 (Ohio 2011) (holding that insurance liquidator was not bound by insolvent company’s arbitration agreement). This means that a company whose counterparty goes into rehabilitation or liquidation may face claims years beyond what may have been anticipated or reserved and may do so in a forum that was not anticipated at the time of contracting. Against this background, it may be well worth exploring options with liquidators early in the receivership process such as a commutation or a loss portfolio transfer and wrapping such transactions with a general release so as to avoid later claims or issues.
Tips and takeaways.
Medical professional liability, nursing home, business interruption, and director and officer coverage, among other lines, may see increased claim activity as losses develop in relation to crisis and pandemic planning and management and as claims develop against insureds who provide professional or other services to persons inflicted with the novel coronavirus. However, companies principally writing in other lines are not immune to investment losses and credit risk and can be a source of potential counterparty liability.
While each counterparty potentially in the zone of insolvency presents a unique set of circumstances, there are general tips that apply universally:
- Document in writing the arm’s length nature of the relationship and any transactions;
- Make certain to disclose any transactions to regulators that are required to be disclosed and obtain regulatory approval or written buy-in, if possible;
- Avoid deals that seem too good to be true or deals that seem to unduly advantage a counterparty’s insiders at the potential expense of the company or its creditors.
On February 27, 2020, the Illinois State Senate referred SB2330, which if enacted would create the Data Transparency and Privacy Act (the “Proposed Act”), to its Judiciary Committee. The Proposed Act would apply to “businesses”, including insurers, intermediaries, and other third-party service providers, who collect or disclose the personal information of 50,000 or more persons, Illinois households, or a combination thereof or who derive 50% or more of their business’s annual revenue from the sale of personal information. As currently drafted, SB2330 may apply to insurers and other affiliates who write a limited number of policies in Illinois but meet the statutory thresholds through business written outside of Illinois. While the Proposed Act contains a carve-out for personal information collected, processed, sold, or disclosed under the Gramm-Leach-Bliley Act, SB2330 may still have applicability to many insurers and reinsurers admitted to write business in Illinois and may also be of particular note to surplus lines carriers from both an enterprise and an underwriting perspective.
Under SB2330, Illinois consumers, including policyholders who meet the statutory definitions, would have several broad rights concerning personal information: (1) the right to transparency, (2) the right to know, and (3) the right to opt out, correct, and delete. SB2330, 101st Gen. Assemb., Reg. Sess., §§15, 20, 25 (Ill. 2020). Businesses who meet the statutory definition would be required to establish a procedure for collecting consumers’ requests and also for authenticating the consumer making each request. Id. at §30(a). The Proposed Act would mandate a response to a consumer’s request within 45 days. Id. at §30(e). Each impacted business would be required to post links on its website and mobile applications for the purpose of processing consumer requests. Id. at §30(b).
A violation of the Proposed Act would be statutorily deemed an unlawful practice under the Consumer Fraud and Deceptive Business Practices Act. Id. at §40(b). Whether such a finding is constitutionally permissible is something which may need to be tested if the Proposed Act is enacted depending upon regulatory guidance and interpretation. The Illinois Attorney General would be tasked with enforcement of the Proposed Act in terms of alleged violations of the Illinois Consumer Fraud and Deceptive Business Practices Act. Id. Consumers would also have a right of action in the event of “an unauthorized access and exfiltration, theft, or disclosure as a result of the business’ violation of the duty to implement and maintain reasonable security procedures and practices . . . .” Id. at §40(a).
As of March 4, 2020, the Proposed Act has not been scheduled for hearing and has only received a single reading, in a single chamber of the General Assembly. The Illinois Constitution mandates that each bill shall be read by title on at least three different days in each house. ILL. CONST. art. IV, §8(d). It is unclear whether the Proposed Act will meet a similar fate as previous data privacy legislation proposed in recent Illinois sessions. As the Proposed Act has an effective date of July 1, 2021, as currently drafted, it is unclear whether data privacy is something that might have legs in the regular session or something that could be resurrected in the veto session following this November’s election. Either way, SB2330 and similar proposed legislation in other States are of note particularly for insurers who write in multiple jurisdictions and may face an obligation to comply with data privacy laws, each with their own nuance, across multiple jurisdictions.
Representations and warranties insurance transfers the risk of certain known unknowns and unknown unknowns from transaction participants to the underwriting insurer. Such risk transfer can create moral hazard especially where one of the parties to the transaction, i.e. the seller (and also the underwriting broker), receive the majority, if not all, remuneration on the deal and exit the stage before the unknowns become knowns. It also can create a situation where insurers who seek an expanded share of what has been called a “prolonged sellers’ market” may face deteriorating claims and be left with an undesirable position when the economic waters recede.
What is Representations and Warranties Insurance
Representations and warranties insurance provides coverage for financial losses resulting from a breach of a representation or warranty made by a seller in a purchase and sale agreement. It is a subset of transactional risk insurance and sometimes called M&A insurance or warranty and indemnity insurance. Counterparties used to address these type of risks through negotiated escrows which kept the risk allocated among the parties to the transaction. Transactional parties often now lay that risk off to an insurer’s balance sheet.
The Domestic Market Has Grown at an Astronomical Pace
The market for representations and warranties insurance exploded in the past decade. According to one of the major brokers, total industry limits (combined primary and excess) approached $14.7 billion and generated approximately $526.5 million in premium on more than two-thousand issued policies in 2016. That is remarkable growth for a product that reportedly generated $10 billion in bound coverage worldwide in 2013 and was on virtually no one’s radar screen before the recent M&A uptick which followed the Great Recession.
As of 2018, a representations and warranties policy is generally priced between 2.25% to 4% of the limit of liability with market capacity and appetite for large transactions increasing. Typically, 1-3% of enterprise value is retained, but it has been reported that recent retentions have gone below 1% as the market tightens among insurers competing for market share.
Reported Claims Experience
AIG was one of the first insurers to write representations and warranties insurance (referred to as warranty & indemnity insurance outside the domestic market) and has published three annual reports on its claims experience. According to those reports, approximately one-in-five (19.4%) policies written result in a claim. The largest deals from a dollar perspective (deal size over $1 billion) generate the highest claims frequency (24%) and the largest average claim ($19 million). An increased year-on-year claims frequency was reported across all classes of deal size. According to AIG, nearly half of all material claims (46%) resulted in what was termed a mid-sized payout (payment on the claim between $1 million to $10 million) with an average settlement of $4 million over the five year period of policies written between 2011-2016. That reported average settlement was up, from $3.5 million, in the prior report.
In 2018, AIG for the first time provided data broken down on breach type by industry sector as set forth below.
AIG’s reported claims figures suggest that insureds have become more sophisticated in their use of the product with an impact on the frequency and severity of claims.
Judicial Determinations of First Impression
In 2017, the United States Court of Appeals for the Seventh Circuit became the first court of review to address a claim for indemnity under a representations and warranty policy in a published opinion. A $23.4 million stock purchase deal for a specialty dairy products company which resulted in a $10 million settlement between the corporate buyer and the family members who had sold their 100% interest in the company was at issue before the court. The sellers purchased a seller’s warranty and indemnity insurance policy with an aggregate cover of $10 million over a $1.5 million retention which provided coverage for various representations made in the deal documents on a claims made basis with a policy period extending for six years after the closing.
The Seventh Circuit affirmed summary judgment in favor of the insurer. The court held that the settled claims were for breach of general representations for which the deal documents capped damages at $1.5 million. As a result, the damages attributable to covered claims (fraud claims were excluded under the policy) were limited to the amount of the insured’s $1.5 million retention such that the insurer had no liability. The court recognized that had the settlement been structured in a different way or the claims been litigated, such that allegations were made against the sellers in a complaint filed with a court of record subject to Federal Rule of Civil Procedure 11 or a state court equivalent, then the insurer might have been liable. The saving grace for the insurer here appears to have been that the insureds rushed to settle and did not structure their settlement in a way to invoke coverage. The court also recognized that the insured failed to give the insurer sufficient time to review and approve/reject the settlement before consummation.
While Ratajczak resulted in a decision for the insurer, the opinion left much room for creative buyers or sellers to structure claims in a way to obtain coverage where the policy drafter might have intended otherwise.
The Current M&A Cycle
M&A activity remains robust and many leading experts predict the trend to continue through 2018. Representations and warranties products appear here to stay and have a place in a well-managed portfolio. However, these policies have long tail risk typically providing coverage for general representations up to three years and fundamental representations up to six years with some market participants reportedly offering longer coverage periods in an attempt to capture market share. What will happen if the current M&A market turns and current policyholders look to hedge loses by making increased claims or potentially assigning their interest in policies including assignments made in bankruptcy. Insurers would be well served to keep an eye on market conditions and work through strategies to address any increase in claims percentage or severity in advance of any economic downturn as such claims experience may directly impact loss ratios.
 The phrase unknown unknowns was popularized by former Secretary of Defense Donald Rumsfeld who on February 12, 2002, stated at a Department of Defense news briefing: “Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know. And if one looks throughout the history of our country and other free countries, it is the latter category that tend to be the difficult ones.” Transcript available at http://archive.defense.gov/Transcripts/Transcript.aspx?TranscriptID=2636, last visited May 24, 2018.
 AIG, Claims Intelligence Series, M&A Insurance – The New Normal?, May 2018, available at https://www.aig.com/content/dam/aig/america-canada/us/documents/insights/aig-manda-claimsintelligence-2018-r-and-w.pdf, last visited May 24, 2018.
 Gallagher Market Conditions, January 2018, available at https://www.ajg.com/media/1701903/rw-market-conditions-2018.pdf, last visited May 24, 2018.
 AIG, Claims Intelligence Series, M&A Insurance – The New Normal?, May 2018, available at https://www.aig.com/content/dam/aig/america-canada/us/documents/insights/aig-manda-claimsintelligence-2018-r-and-w.pdf, last visited May 24, 2018.
 Id., Source of Reprinted Graphic.
 Ratajczak v. Beazley Solutions, Ltd., 870 F.3d 650 (7th Cir. 2017).
 See, JP Morgan’s 2018 Global M&A Outlook, available at https://www.jpmorgan.com/jpmpdf/1320744801603.pdf, last visited May 24, 2018, and Deloitte’s The State of the Deal, M&A Trends 2018, available at https://www2.deloitte.com/content/dam/Deloitte/us/Documents/mergers-acqisitions/us-mergers-acquisitions-2018-trends-report.pdf, last visited May 24, 2018, among other forecasters.
Duane Morris partner Max H. Stern will be moderating a panel at the American Conference Institute’s (ACI) National Forum on Insurance Allocation on October 29, 2014 at the Carlton Hotel on Madison Avenue in New York. Mr. Stern’s session is titled, “In-House Roundtable: Counsel and Claims Professional Insights on New and Emerging Issues in Insurance Coverage and Allocation,” and will take place at 9:35 a.m.
For more information or to register for this event, please visit the American Conference Institute’s website.
Duane Morris partner Dominica C. Anderson will be speaking at the PIAA’s Corporate Counsel Workshop. Ms. Anderson’s session is titled, “ECO/XPL and the Mega-Verdict: Is This the New Normal?” and will begin at 2:45 p.m. on Thursday, October 16, 2014 at the Fairmont Hotel Vancouver.
For more information about this event, please visit our Duane Morris Events Page.
For a claims-made policy, the policy holder is to provide notice of a claim: (1) during the same policy period in which the policyholder received the claim and (2) “as soon as practicable.” Otherwise, the claim may be denied because of late notice. New Jersey has determined that six months or more is not “as soon as practicable.”
Holding: The Superior Court of New Jersey, Appellate Division, held in Templo Fuente de Vida Corp. v. National Union Fire Insurance Company of Pittsburgh, P.A., that: (1) notice of a claim was not provided “as soon as practicable” when sent six months after service on the insured of the underlying complaint and (2) an insurer on a claims-made policy does not have to show that it was prejudiced by the late notice.
A California Court of Appeal has affirmed the concept that a successful defendant who is entitled to an attorney fee award can seek an award which is greater than the fees actually billed by the insurance appointed defense counsel who represented the defendant.
In Syers Properties III, Inc. v. Ann Rankin et. al., 226 Cal.App.4th 69 (2014), defendants successfully obtained a judgment of nonsuit in a legal malpractice action. Defendants were entitled to attorney fees by reason of their fee agreement with the plaintiff which entitled the prevailing party to attorney fees. Defense counsel sought and successfully obtained an award of attorney fees which were not tied to the rates actually charged for the representation by presenting evidence to the trial court that a reasonable rate for the representation was actually higher than the rates charged. The court noted that the benchmark for a fee award is reasonableness and there is no requirement that the reasonable market rate mirror the actual rate billed. In concluding that a reasonable rate could exceed the actual rate billed, the court acknowledged that attorneys who do work for insurance companies often work at what are arguably below market rates (in part because of the volume of work). Thus, because counsel was able to convince the trial court that the skill, expertise and experience necessary to successfully litigate the case would reasonably have been charged at higher rates, the court of appeal concluded that the trial court was within its discretion in concluding that a higher rate was reasonable and justified.
On July 29, 2014, the Third Circuit issued an interesting court decision concerning the Medicare Secondary Payer Act (MSP) that may provide guidance to the parties in tort litigation, particularly in New Jersey tort litigation, in a case styled Taransky v. United States. The Taransky case involved a slip and fall accident involving a settlement by a tortfeasor who tried to resolve the Medicare lien in the settlement process. The case pitted two statutes against each other, the Medicare Secondary Payer Act and a New Jersey statute prohibiting tort claimants from recovery twice under medical insurance and liability insurance. In the end, the Third Circuit found that the plaintiff had to reimburse Medicare from the tort settlement for medical bills incurred by Medicare. Continue reading Third Circuit Issues Decision Concerning Medicare Secondary Payer Act in New Jersey