Target Data Breach Lawsuits Increase Focus on Insurance Coverage for Cyber-Risk

I just finished a very fine (and, unusual for a lawyer blog, concise!) piece on the deluge of lawsuits already filed against Target entitled The Target Data Breach Lawsuits: Why Every Company Should Care.  I recommend it.  The author does not touch on the insurance coverage issues raised by data breach litigation, and who can blame him.  The author probably realized that his subject matter - causes of action, standing, multi-district litigation - was dry enough.  No need to put absolutely everyone to sleep by bringing up insurance.  But that's my stock in trade.  So are suits like these covered by traditional GL policies?  Are you sitting down, 'cause this will be a shocker... it depends.  It depends on what the plaintiffs allege, it depends on what the hackers got, it depends on what jurisdiction you are in.  As it happens, right before the Target news came out I had begun working on some CE (continuing education) materials for insurance professionals on data breach and cyber-risk coverage at the suggestion of a good friend in the industry.  I'll share some of the highlights here as I develop those materials, so please subscribe via RSS or email for further updates!  And Happy New Year, readers!

"Pay and Chase" Jeopardized by Court of Appeals

Policyholders representing general contractors and developers frequently urge defending carriers to "pay and chase" - in other words, settle with the owner ("pay") and then subrogate against the subcontractors or design professionals whose work caused the alleged damage ("chase") to get reimbursed for the settlement with the owners.  Many carriers are increasingly leery of this approach, and unfortunately a new decision from the Court of Appeals is likely to further dampen their enthusiasm.  In Montara Owners Ass'n v. LaNoue Development, the developer's carrier (Zurich) agreed to pay and chase, paying $4 million to resolve the developer's liability.  Zurich settled with almost all subcontractors, but proceeded to trial against one, Advanced Construction ("Advanced") (referred to in the decision as Sharabarin, the name of the "dba" owner).

At trial Advanced succeeded on a directed verdict motion to reduce the total amount that LaNoue could seek in damages by knocking out two chunks from Zurich's subrogation right: 1) amounts that Zurich had been reimbursed by settling subcontractors; 2) an amount that Zurich had paid in settlement out of a policy that pre-dated Advanced's construction work on the project.  Advanced's argument as to #1 was essentially that Zurich could not get a double recovery; its argument on #2 was that because it could not have caused property damage during that early Zurich policy period, there was no subrogation right for that period.  LaNoue (Zurich) argued that subrogation merely puts the carrier in the insured's shoes, and does not impose any additional burdens of proof on a subrogating carrier.

The Court of Appeals reversed the directed verdict on #1, holding that property damage caused by other subcontractors, for which those subcontractors paid to settle, had nothing to do with the claims against Advanced, and since there was no overlap, the trial court should not have pretended that there was a concern about "double recovery."  But the Court of Appeals upheld the #2 reduction, for the policy period prior to Advanced's work, "because Sharabarin could not have been responsible for covered losses during that timeframe."

As all insurance professionals know, carrier allocations of indemnity payments that are made from multiple policies are idiosyncratic and usually have nothing to do with the amount of property damage that actually occurred in any particular policy period.  That issue often comes up in litigation over prior exhaustion of policies: a carrier will claim that a policy was exhausted in prior litigation and that therefore no defense was owed, but policyholder counsel can often establish that the allocation of losses to the policy in question was arbitrary, that the insured was not consulted, and that the policy was in fact no exhausted at all.  Indeed it appears that in this case Zurich put in evidence that the amount that it allocated to the earliest, pre-Advanced policy was arbitrary.  It is unclear why the Court of Appeals ignored this evidence.  If Zurich appeals, policyholders may want to weigh in on the impact of the decision on them.

Former Insurance Defense Counsel's Firm Permitted to Represent Insured Against Carrier

The Portland Harbor Superfund Site continues to generate new coverage-related law on issues beyond environmental contamination.  In a recent ruling from Oregon's federal court, Judge Acosta permitted Stoel Rives to substitute in as coverage counsel for steel company Evraz, Inc. in litigation between Evraz and many of its former carriers over coverage at the Superfund site.  The carriers, led by first named defendant Continental Insurance, contended that Stoel Rives had a conflict because at one point Continental was paying the firm to do the substantive environmental defense work for Evraz.  Continental claimed that under Oregon State Bar ethics opinions, that created a default "tripartite" relationship in which both Evraz and the insurance companies had been Stoel Rives' clients, meaning that there was a "prior client conflict" disqualifying Stoel Rives from prosecuting the coverage claim against Continental.  Judge Acosta held that no default status could be created by the ethics opinions because they have been held to be only "advisory."  The court went on to analyze the conflict issue under Oregon case law, and found that because Stoel Rives' environmental lawyers had not been retained initially by Continental, were not paid directly (but only indirectly) by Continental, and had gone to pains to advise Continental that they did not represent Continental during the prior work, there was no prior client conflict.

Washington Federal Court Permits Deposition of Carrier's Former Coverage Attorney

On October 30, 2013 Judge Martinez of the Western District of Washington permitted the policyholder in a long-running bad faith case to take the deposition of the carrier's former coverage counsel, Joanne Henry, about the coverage analysis that she performed for the carrier leading to the carrier denying the tender of defense.  This decision relied heavily on the landmark 2011 Cedell decision from the Washington Supreme Court which, broadly speaking, abrogated in part the attorney-client privilege where the attorney was acting as an adjuster, taking on one of the "quasi-fiduciary" roles of a potentially defending insurer.  Judge Martinez held that because the policyholder had reason to believe that Ms. Henry did the entire coverage investigation herself, in addition to performing legal analysis of the policy, the policyholder could take her deposition, although the carrier could object if a question that genuinely intruded into the privilege was asked.

Implementation of Environmental Coverage Claims Mediation Program Underway

The recent amendments to Oregon's Environmental Cleanup Assistance Act (OECAA) included a potentially useful tool in the policyholder toolbox - one that could benefit all sides and the environment as well.  The amendments provided that an insured could demand that an insurer participate in a mediation over a broad range of environmental coverage disputes, and if the insurer refuses, that is a per se bad faith claims handling practice subjecting the carrier to increased damages.  The Oregon Department of Justice was given the responsibility for creating an environmental coverage mediation program including hiring a mediation service provider (MSP) to administer the program and writing regulations governing issues like qualifications and rates.  DOJ convened a public meeting of stakeholders this past Monday, December 2, in Salem, which was attended by insurers, policyholder advocates, and many representatives of the mediation community.  DOJ has also set up a website for the program which will track its progress.  There are a number of issues under discussion.  Let me know if you have thoughts that you'd like conveyed through the Advisory Committee that is being set up, and stay tuned.

Wa. Court of Appeals: Exhaustion of Primary Layer Means Actual Payment

In a new decision that has generated some interest nationally, the Washington Court of Appeals held November 12, 2013 that if an excess policy's attachment language is sufficiently restrictive, the excess policy will not be triggered unless the primary carrier actually pays the full amount of its limits.  In this case, Quellos Group LLC v. Federal Insurance and others, the insured financial advisory firm was called on the carpet by federal regulators for shady tax shelter schemes.  As often happens in such regulatory-type cases, involving disgorgement, fines, damages, and injunctive relief, there were many question about what the primary layer policy would actually cover.  Quellos and its primary-layer carriers settled those coverage disputes with the primary carriers paying Quellos less than full policy limits.  So far, so good.  Quellos then paid the difference between what the primary carriers paid and the primary limits, therefore reaching the "attachment point" for the excess layer policies.

Not so fast, said the Court of Appeals.  The Federal excess policy stated that coverage "shall attach only after the insurers of the Underlying Insurance shall have paid in legal currency the full amount of the Underlying Limit." The Indian Harbor policy stated that coverage "will attach only after all of the Underlying Insurance has been exhausted by the actual payment of loss by the applicable insurers thereunder."  The court read these provisions as literally requiring, as a pre-condition to any coverage, that the primary carrier itself pay the the full limits.  The court rejected Quellos' argument that these provisions should function like many of the other "conditions of coverage" that aren't really conditions at all, but are treated more like exclusions, where the carrier has the burden of showing that it was prejudiced in some way by the insured's failure to comply with the condition.  The court also rejected Quellos' public-policy argument, noting that there are policy forms available that allow the insured to do just what Quellos tried to do in triggering excess coverage.

From the policyholder's perspective this decision is bad news, and it is not in keeping with the general trend (with many exceptions) in Washington law to tackle coverage questions from a practical, policyholder-oriented perspective.  These excess carriers contracted to provide coverage only if a certain amount of liability was assessed and paid out.  What in the world does it matter to them who pays the underlying limit?  Unfortunately this decision is joining a trend in the case law nationally on this issue that is against policyholders.  Hopefully the Washington Supreme Court will accept review and overturn the decision.

Benefits of Involving Counsel In Choosing Your Insurance Program

All companies routinely review their insurance coverage programs, usually through risk management talking to a trusted insurance broker.  Today I came across this excellent "Sound Advice" podcast from Tonya Newman, a colleague at Neal Gerber & Eisenberg in Chicago, about the reasons that companies should involve counsel in discussions at renewal time.  It is of course fairly self-serving to say so, but insurance coverage counsel can provide a perspective on what insurance to buy that brokers often cannot.  If coverage counsel have recently represented the company in coverage disputes they may be more intimately familiar with how standard-form exclusions intersect with the company's products or business practices.  And because insurance procurement decisions should involve a good deal of candid self-assessment, and review of prior claims, it may be worth while to consider doing that kind of assessment inside the attorney-client privilege rather than having the conversations strictly with an insurance broker who may be subject to subpoena in a later claim.  The presentation is very well done and I commend it to other policyholder counsel, brokers, and risk managers.