Insurance Law Alert

July/August 2016

In This Issue
In Pair of Decisions, Wisconsin Supreme Court Overrules Prior Case Law
and Clarifies Insurer’s Right to Deny Defense Based on Policy Exclusions
In two recent decisions, the Supreme Court of Wisconsin reinforced an insurer’s right to refuse
to defend or provide coverage based on unambiguous policy exclusions. Marks v. Houston
Casualty Company, 2016 WL 3545848 (Wis. June 30, 2016); Water Well Solutions Service
Group Inc. v. Consolidated Insurance Company, 2016 WL 3545838 (Wis. June 30, 2016).
(Click here for full article)“They are just
exceptional at what
they do, they know
coverage law backwards
and forwards and they areexcellent litigators.”–Chambers 2016,
quoting a client

Seventh Circuit Rules That Pill Mill Suit Against Pharmaceutical
Distributors Alleges Bodily Injury Within Scope of General Liability
Coverage
The Seventh Circuit ruled that allegations that a pharmaceutical distributor’s involvement
in a pill mill caused the State of West Virginia to pay millions of dollars for drug abuse careconstituted a claim for bodily injury under a general liability policy. Cincinnati Ins. Co. v. H.D.
Smith, L.L.C., 2016 WL 3909558 (7th Cir. July 19, 2016). (Click here for full article)

Texas Court Addresses Scope of Coverage for Ponzi Scheme Losses
A Texas federal district court ruled that a commercial crime policy did not provide coverage forlosses arising out of a Ponzi scheme because the policyholder did not “own” the funds for which
it sought indemnification. Cooper Indus., Ltd. v. National Union Fire Ins. Co. of Pittsburgh,PA, 2016 WL 3405295 (S.D. Tex. June 21, 2016). (Click here for full article)

When Insurer Denies Coverage, Policyholder Does Not Breach
Cooperation Clause by Settling Without Insurer Consent, Says New YorkCourt
A New York trial court ruled that Bear Stearns did not breach its duty to cooperate by settlingunderlying claims without insurer consent because the insurers had unequivocally denied
coverage. J.P. Morgan Sec. Inc. v. Vigilant Ins. Co., 2016 WL 3943731 (N.Y. Sup. Ct. New York
Cnty. July 7, 2016). (Click here for full article)

District Court’s Refusal to Vacate Orders After Settlement Was Erroneous,
Says Eleventh Circuit
The Eleventh Circuit ruled that a Florida federal district court erred in refusing to vacatesummary judgment orders following the parties’ execution of a settlement agreement
conditioned on the vacatur of those orders. Hartford Cas. Ins. Co. v. Crum & Forster Specialty
Ins. Co., 2016 WL 3741972 (11th Cir. July 12, 2016). (Click here for full article)

Simpson Thacher & Bartlett LLP

1

New Jersey Supreme Court Rules That Damage Caused by Subcontractors’
Faulty Workmanship Is “Property Damage” and an “Occurrence” Under
General Liability Policies
The New Jersey Supreme Court ruled that consequential damage caused by subcontractors’
negligent workmanship is property damage and an occurrence for purposes of general liability
coverage. Cypress Point Condo. Assoc., Inc. v. Adria Towers, L.L.C., 2016 WL 4131662 (N.J.
Aug. 4, 2016). (Click here for full article)

New Jersey Appellate Court Rules That Stunted Chicken Growth Is
Property Damage Caused by an Occurrence
A New Jersey appellate court ruled that stunted chicken growth caused by the ingestion of adrug intended to control a common intestinal disease is a covered occurrence and constituted
property damage under general liability policies. Phibro Animal Health Corp. v. National
Union Fire Ins. Co. of Pittsburgh, PA, 2016 WL 3747538 (N.J. App. Div. July 14, 2016).
(Click here for full article)

All Loss Attributable to Employee Misconduct Constitutes a Single Loss,
Outside the Scope of Policy Period, Rules Sixth Circuit
The Sixth Circuit ruled that all loss caused by one employee’s misconduct was a “single loss”
under an employee-theft policy and that there was no coverage under the policy because theemployer had “discovered” the loss prior to executing the insurance policy. Constr. Contractors
Emp’r Grp., LLC v. Federal Ins. Co., 2016 WL 3675572 (6th Cir. July 11, 2016). (Click here forfull article)

Maryland Court Rules That Insurer Must Defend Deceptive Marketing
Claims Against Career Colleges
A Maryland federal district court ruled that an insurer was obligated to defend deceptive
marketing claims, finding that a professional services exclusion did not apply and that a
subpoena is a “claim.” Educ. Affiliates Inc. v. Federal Ins. Co., 2016 WL 4059159 (D. Md. July28, 2016). (Click here for full article)

Extrinsic Evidence Cannot Create Policy Ambiguity, Says Colorado
Supreme Court
The Colorado Supreme Court ruled that a policyholder may not rely on extrinsic evidence toestablish a policy ambiguity. Rather extrinsic evidence may only be used to determine theparties’ intent if an ambiguity appears in the four corners of the document. American Family
Mutual Ins. Co. v. Hansen, 2016 WL 3398507 (Colo. June 20, 2016). (Click here for full article)

New York Court Addresses Late Notice, Retention Warranty and Follow
the Fortunes In Reinsurance Dispute
A New York trial court addressed arguments relating to late notice, warranty of retention andfollow the fortunes in a reinsurance coverage dispute. Granite State Ins. Co. v. Clearwater Ins.
Co., No. 653546/11 (N.Y. Sup. Ct. New York Cnty. June 17, 2016). (Click here for full article)2

Duty to Defend
Alert:In Pair of Decisions, Wisconsin
Supreme Court Overrules Prior
Case Law and Clarifies Insurer’s
Right to Deny Defense Based On
Policy Exclusions
In two recent decisions, the Supreme Courtof Wisconsin reinforced an insurer’s right torefuse to defend or provide coverage based onunambiguous policy exclusions.
In Marks v. Houston Casualty Company,
2016 WL 3545848 (Wis. June 30, 2016),
the court ruled that an insurer had no duty
to defend underlying lawsuits based on abusiness enterprise exclusion, rejecting priorcase law that suggested that an insurer that
refuses to defend relinquishes its right to relyon policy exclusions in subsequent coveragelitigation.
The coverage dispute arose out of lawsuits
filed against David Marks and Titan Global
Holdings, a holding company for which Marks
was the principal shareholder and chairman.
The suits alleged fraud, misrepresentation,
negligence and statutory claims based on thecollapse of various business arrangements.
Marks tendered defense of the suits to
Houston Casualty, his professional liability
insurer. Houston refused to defend on
several bases, including a business enterprise
exclusion that excluded coverage forliability arising out of Marks’ services
and/or capacity as an officer, director,
partner, trustee, or employee of a businessenterprise not identified in the policy
declarations. The only entities named in
the declarations were two trusts for which
Marks served as trustee. A Wisconsin trial
court granted Houston’s summary judgment
motion, finding that the business enterprise
exclusion precluded coverage.
The Wisconsin Supreme Court assumed,
without deciding, that the policy provided an
initial grant of coverage for the underlying
claims. The court then held that the businessenterprise exclusion unambiguously applied
because all of the underlying allegations werebased on Marks’ position as director or officer
at Titan. Any allegations relating to Marks’position as trustee for the trusts (which would
fall outside the scope of the exclusion) were“conspicuously absent” from the underlying
complaints.
Significantly, the court rejected the argumentthat an insurer that denies coverage andrefuses to defend is estopped from relying
on policy exclusions in subsequent coveragelitigation. The court rejected holdings froma series of appellate court cases supporting
this proposition, finding that they conflictedwith well-established Wisconsin precedentand constituted a “stunted strand oflaw that conflicts with our four-corners
jurisprudence.” The court clarified that aninsurer is estopped from contesting coverage
only if a court has determined that it breached
its duty to defend.
The court also dismissed Marks’ assertion
that the exclusion rendered the policy
illusory because it “completely swallows thecoverage granted in the insuring agreement”
by excluding coverage for liability arisingout of Marks’ services as a trustee, among
other things. In this context, the court heldthat even assuming a particular portion of
the exclusion (relating to Marks’ capacity
as trustee) rendered the policy illusory, theappropriate remedy would be reformation ofthat specific clause rather than voiding theexclusion in its entirety.
In Water Well Solutions Service Group Inc.
v. Consolidated Insurance Company, 2016
WL 3545838 (Wis. June 30, 2016), issued
on the same day as Marks, the Wisconsin
Supreme Court reinforced a strict “fourcorners” rule governing an insurer’s duty to
defend and held that an insurer may refuse
to defend based on a policy exclusion without
resort to extrinsic evidence, even where it isundisputed that the policy provides an initial
grant of coverage.
Water Well tendered defense of a negligencesuit to Consolidated Insurance. Consolidated
conceded that its general liability policy’s
grant of coverage encompassed the claims,
but refused to defend based on two policy
exclusions. A Wisconsin trial court andappellate court agreed, finding that policy
exclusions barred coverage. On appeal to
the Wisconsin Supreme Court, Water Well
asked the court to “craft an exception to thefour-corners rule allowing courts to consider
extrinsic evidence when an insurer has
unilaterally decided that no duty to defend
exists based on exclusions in the insurance
policy.” The court declined to do so, stating3

that “[w]e now unequivocally hold that there
is no exception to the four-corners rule induty to defend cases in Wisconsin.”
The court also rejected Water Well’sassertion that under the four-corners rule,the court’s comparison of the complaint to
the insurance policy should be limited to the
portion of the policy providing the initial
grant of coverage. Instead, the court ruledthat in evaluating an insurer’s duty to defend,
the entire policy, including exclusions,should be examined. Specifically, the court
concluded that a “Your Product” exclusion
unambiguously barred coverage because theunderlying complaint alleged only damage
to Water Well’s own products. Rejecting
Water Well’s argument that damage to otherproperty could be reasonably inferred fromthe underlying allegations, the court refused
to engage in “guess-work and supposition
repeatedly rejected in Wisconsin’s duty-todefend jurisprudence.”

Bodily Injury
Alert:

Seventh Circuit Rules That Pill
Mill Suit Against Pharmaceutical
Distributors Alleges Bodily Injury
Within Scope of General Liability
Coverage
The Seventh Circuit ruled that allegations thata pharmaceutical distributor’s involvement
in a pill mill caused the State of West Virginia
to pay millions of dollars for drug abuse careconstituted a claim for bodily injury under ageneral liability policy. Cincinnati Ins. Co. v.
H.D. Smith, L.L.C., 2016 WL 3909558 (7thCir. July 19, 2016).
West Virginia sued H.D. Smith and otherpharmaceutical distributors for allegedly
contributing to an epidemic of prescription
drug abuse. The complaint alleged that Smith
negligently or recklessly provided pharmacies
with vast quantities of prescription drugs
that fueled consumers’ drug additions.
Among other things, the State alleged thatit spent millions of dollars caring for drugaddicted residents as a result of such pill
mill operations. Smith tendered defense of
the suit to Cincinnati Insurance pursuant toa general liability policy. Cincinnati refused

to defend and sought a declaration that its
policy did not cover the suit because it did
not seek damages “because of bodily injury.”
An Illinois federal district court agreed andgranted the insurer’s summary judgment
motion. The Seventh Circuit reversed.
The underlying complaint alleged that
Smith negligently distributed drugs andtherefore “interfered with the right of West
Virginians to be free from unwarranted
injuries, addictions, diseases and sicknesses.”
The Seventh Circuit reasoned that these
allegations sufficiently alleged damages
because of bodily injury. In so ruling, thecourt distinguished Medmarc Cas. Ins. Co. v.
Avent Am., Inc., 612 F.3d 607 (7th Cir. 2010)(discussed in our September 2010 Alert),
which held that an insurer need not defendclass action suits alleging that baby bottles
and related accessories were contaminatedwith a toxic chemical. The court explainedthat the underlying claims in Medmarc
did not allege damages because of bodily
injury because there were no allegations
that the plaintiffs ever used the products
or were exposed to the harmful substances.
In contrast, the underlying complaint here
alleged that consumers ingested drugs that
had been negligently distributed by Smith.
The court therefore concluded that Cincinnati
was required to defend the suit.

Ponzi Scheme
Alert:

Texas Court Addresses Scope of
Coverage for Ponzi Scheme Losses
A Texas federal district court ruled that acommercial crime policy does not coverlosses arising out of a Ponzi scheme because
the policyholder did not “own” the funds
for which it sought indemnification. Cooper
Indus., Ltd. v. National Union Fire Ins. Co. of
Pittsburgh, PA, 2016 WL 3405295 (S.D. Tex.
June 21, 2016).
Cooper invested approximately $175 million
in Westridge Capital Management, a
registered investment advisor. Unbeknownst
to Cooper, Westridge was part of a Ponzi
scheme orchestrated by individuals who
owned a controlling share of Westridge, as
well as two other related entities (WGTC,4

a registered broker-dealer, and WGTI, an
unregulated entity utilized to facilitate
investments into WGTC). Before thescheme was discovered, Cooper recouped
its investment plus earnings in Westridge’s
equity fund. However, Cooper did not redeem
its investment in Westridge’s bond fund.
After the fraudulent activity was discovered,a receiver appointed to protect investors’interests initiated a claw back action against
Cooper to recover its earnings from the equity
fund investment. Cooper ultimately settledwith the receiver, and then sought coverage
from National Union for lost investments,
earnings and interest. National Union denied
coverage, and Cooper brought suit, claiming
losses of nearly $20 million.
The court ruled that the policy did not provide
coverage because Cooper did not “own” thefunds it lost and the policy limited coverage toproperty “[t]hat you own or lease.” National
Union argued that Cooper did not own thefunds because it did not invest directly inWestridge. Rather, Cooper loaned money to
WGTI via promissory note, and WGTI theninvested that money in WGTC. National
Union argued that once Cooper loaned
the money to WGTI, it no longer had anownership interest in the property. The court
agreed. The court explained that because both
entities were limited liability partnerships,
Cooper held, at most, a limited partnershipinterest in those entities, which under
Delaware law, does not confer ownership in
the underlying property. A Minnesota court
reached the same conclusion in a coverage
dispute arising out of the same Ponzi scheme.
See 3M Co. v. National Union Fire Ins. Co. of
Pittsburgh, PA, 2015 WL 5687879 (D. Minn.
Sept. 28, 2015) (discussed in our October
2015 Alert).
Although the ownership issue was outcomedeterminative, the court also addressed theavailability of coverage for the lost earnings.
The court held that “[t]o the extent thatsome of that money was Cooper’s legitimate
earnings, Cooper would be entitled tocompensation under the Policy.” The court
rejected National Union’s argument that
Cooper was not entitled to compensation
because it was a “net winner” overall in its
investments. The court reasoned that thepolicy insured Cooper against theft regardlessof whether it was theft of principal orearnings. The court distinguished Horowitz
v. Am. Int’l Grp., Inc., 2010 WL 3825737(S.D.N.Y. Sept. 30, 2010), aff’d, 498 Fed.
Appx. 51 (2d Cir. 2012) (discussed in our
November 2010 Alert), which held that lost
profits in the Madoff Ponzi scheme werefictitious and non-compensable, reasoningthat Horowitz involved a “pure Ponzi scheme. . . in which there were no actual investments
or earnings of any kind.” Here, Westridge
generated over $580 million in profits via
legitimate trading strategies, notwithstanding
the theft of funds.

Settlement Alerts:
When Insurer Denies Coverage,
Policyholder Does Not Breach
Cooperation Clause by Settling
Without Insurer Consent,
Says New York Court

A New York trial court ruled that Bear
Stearns did not breach its duty to cooperateby settling underlying claims without insurer
consent where the insurers had unequivocallydenied coverage. J.P. Morgan Sec. Inc. v.
Vigilant Ins. Co., 2016 WL 3943731 (N.Y.
Sup. Ct. New York Cnty. July 7, 2016).
Bear Stearns sought a declaration that its
insurers were required to indemnify it for
settlements reached with the SEC, the New
York Stock Exchange and private litigants inconnection with deceptive practices claims.
The insurers argued that they had no duty to
indemnify because Bear Stearns breached theconsent to settle and cooperation provisions
in the policies. Bear Stearns moved to dismissthe defenses, which the court granted.
The court held that a consent to settle
provision is a condition precedent to coverageand that a policyholder’s failure to comply
is generally a defense to coverage under thepolicy. However, where an insurer repudiates
liability on the ground that the loss is notcovered under the policy, the policyholder
does not need to obtain the insurer’s
consent to settle, so long as the settlement
is reasonable. The court held that thefactual record established that the insurers
disclaimed coverage prior to Bear Stearns’s
settlement with the SEC because they“consistently asserted, from the inceptionof the regulatory investigations, that thoseinvestigations did not appear to constitutea claim.” The court also found that the5insurers consistently argued that even if theinvestigations constituted a claim, the losses
were uninsurable disgorgement claims. (SeeJanuary 2015, March 2014, June 2013 Alerts).
The court concluded that these factors
established as a matter of law that theinsurers disclaimed coverage prior to Bear
Stearns’s settlement.
Based on this factual finding, the court
rejected the insurers’ argument that they had
not conclusively denied coverage because
they continued to reserve their rights during
litigation and advised Bear Stearns that theirdetermination was “non-final.” The court heldthat the insurers’ other statements “left no
doubt that they were disclaiming coverage.”
The court also dismissed the insurers’
failure to cooperate defense, explainingthat the burden of proving non-cooperation
is “heavy” and that the factual record did
not support the assertion that the insurers“diligently sought Bear Stearns’s cooperationor that Bear Stearns willfully obstructed
these efforts.” Notably, the court held that
an issue of fact existed as to whether thesettlements were reasonable, a determinationthat will ultimately control the insurers’
indemnity obligations.

District Court’s Refusal to Vacate
Orders Based on Settlement Was
Erroneous, Says Eleventh Circuit
The Eleventh Circuit ruled that a Florida
federal district court erred in refusing tovacate summary judgment orders following
the parties’ execution of a settlementagreement conditioned on the vacatur of
those orders. Hartford Cas. Ins. Co. v.
Crum & Forster Specialty Ins. Co., 2016 WL
3741972 (11th Cir. July 12, 2016).
In a coverage dispute between Crum &Forster and Hartford, a Florida district court
issued a series of orders granting summary
judgment and assessing attorneys’ fees andcosts against Hartford. Hartford appealed,
and the matter was thereafter settled in anagreement that was contingent upon theissuance of an order vacating the summary
judgment and costs orders in their entirety.
The district court refused to vacate the orders,relying on Bancorp Mortgage Company v.
Bonner Mall Partnership, 513 U.S. 18 (1994),
which sets out an “equitable approach thatgenerally counsels against granting requests

for vacatur made after the parties settle”
unless “exceptional circumstances” exist. The
Eleventh Circuit reversed.
The Eleventh Circuit ruled that the district
court applied Bancorp incorrectly. In
particular, the Eleventh Circuit found thatthe district court’s categorical denial thatexceptional circumstances exist any time
parties reach a settlement contingent onvacatur is inconsistent with Bancorp’s
emphasis on equitable considerations. In
addition, the Eleventh Circuit concluded
that the district court’s approach todetermining the nature of the public interestin vacatur was overly narrow, stating thatthe district court “fail[ed] to recognize thatthe public interest is not served only by thepreservation of precedent. Rather the public
interest is also served by settlements whenpreviously committed judicial resources are
made available to deal with other matters,
advancing the efficiency of the federal courts.”
The Eleventh Circuit ruled that the proprietyof granting vacatur is determined by“weighing the benefits of settlement to theparties and to the judicial system (and thus
to the public as well) against the harm to
the public in the form of lost precedent.”
Emphasizing the fact-specific nature ofthis analysis, the court explained that two
unusual features of the settlement agreement
mitigated in favor of vacating the district
court orders in the present case: (1) that thesettlement was the result of court-ordered
mediation and was expressly contingent ofvacatur; and (2) both parties to the settlement
sought vacatur.
6

Coverage Alerts:

relating only to replacement costs rather thanconsequential damages.

New Jersey Supreme Court
Rules That Damage Causedby Subcontractors’ Faulty
Workmanship Is “Property
Damage” and an “Occurrence”
Under General Liability Policies

Finally, the court ruled that the “Your Work”
exclusion eliminated coverage for the alleged
water damage, but that coverage was restoredby an exception to the exclusion that provides
that it does not apply where damage arises
out of work performed by a subcontractor.

The New Jersey Supreme Court ruledthat consequential damage caused bysubcontractors’ negligent workmanshipis property damage and an occurrence forpurposes of general liability coverage. Cypress
Point Condo. Assoc., Inc. v. Adria Towers,
L.L.C., 2016 WL 4131662 (N.J. Aug. 4, 2016).

New Jersey Appellate Court Rules
That Stunted Chicken Growth Is
Property Damage Caused by an
Occurrence

The coverage dispute arose after
condominium residents sued a developerand several subcontractors. The underlying
complaints alleged that interior portionsof the building were damaged due to leaks
and water infiltration. The developer’s
general liability insurers refused todefend or indemnify on the basis that thesubcontractors’ faulty workmanship was
not an “occurrence” or “property damage”
under the policies. A New Jersey trial
court agreed, and granted the insurers’
summary judgment motion. An appellate
court reversed, ruling that unintended andunexpected consequential damages caused
by defective work is property damage causedby an occurrence. The New Jersey Supreme
Court affirmed.
The New Jersey Supreme Court reasoned that
allegations of mold growth and other damage
to parts of the building alleged “physicalinjury to tangible property.” The court further
held that the underlying claims alleged
an “occurrence” (defined as “an accident,
including continuous or repeated exposure
to substantially the same general harmful
conditions”) because the subcontractors’
negligent conduct resulted in unintended
and unexpected harm. In so ruling, thecourt rejected the insurers’ argument that adeveloper’s failure to ensure the soundness of
subcontractors’ work arises from a breach ofcontract rather than a covered accident. The
court distinguished New Jersey precedentthat holds that faulty workmanship claims are
not covered under general liability policies,
noting that those cases involved different
policy language from an earlier version of thestandard general liability policy or allegations

A New Jersey appellate court ruled thatstunted chicken growth caused by theingestion of a drug intended to control acommon intestinal disease is a covered
occurrence and constituted property damage
under general liability policies. Phibro Animal
Health Corp. v. National Union Fire Ins. Co.
of Pittsburgh, PA, 2016 WL 3747538 (N.J.
App. Div. July 14, 2016).
Phibro, a manufacturer of animal healthproducts, sold Aviax, a chicken feed additive
designed to prevent certain parasitic diseases.
It was later discovered that Aviax stunted
the growth of chickens, which resulted inlower meat production and increased feed
costs. When customers sued Phibro, it sought
coverage under liability and umbrella policies
issued by National Union, which the insurer
denied. In ensuing coverage litigation, a
New Jersey trial court ruled that the alleged
losses sustained by Phibro’s customers did
not constitute property damage caused byan occurrence within the meaning of thepolicies. The trial court reasoned that thechickens were not physically injured and were
subsequently sold for human consumption.
The appellate court reversed.
The appellate court ruled that the stunted
growth is an “accident” insured by the policies
because the record established that Phibro
did not expect or anticipate that side effect.
In so ruling, the court analogized the scenario
to faulty workmanship, explaining that
there was unexpected damage to somethingother than the insured’s product (here, thechickens). The court further held that thediminished size and weight of the chickens
constituted property damage, reasoning thatthe detrimental alteration in the chickens’
size and shape represented “harm to thephysical condition of the chickens.” The court
7noted that the fact that the chickens were
ultimately sold for consumption was notdispositive of the property damage question,
explaining that the term “physical injury”
was not defined to require that property beunsalable. Alternatively, the court held thateven if physical injury was lacking, the record
established a “loss of use of tangible property
that is not physically injured.” The court
explained that Phibro’s inability to realize
the chickens’ full potential for sale due todiminished size constituted a partial “loss ofuse” of the chickens.

fraud and approximately $1 million remained
unaccounted for. In 2013, Construction
obtained a crime coverage policy fromFederal. The policy covered losses “sustainedat any time and Discovered during the Policy
Period,” but excluded “any loss that an
Insured is aware of prior to the inception dateof [the] policy.” The policy also contained a“Limits of Liability” provision, which statedthat all loss resulting from a single act or
any number of acts from the same employee
are treated as a single loss subject to theapplicable limit of liability.

The court remanded the matter for a factual
determination of whether an “impaired
property” exclusion barred coverage. The
appellate court explained that application of
the exclusion turns primarily on whether thedamaged property can be “restored to use.”
National Union argued that the chickens
could have reached their full expected weight
had they been given more time to grow,whereas Phibro contended that they could not
be “restored to use” in that manner becauseof the chickens’ pre-determined lifespans,
which are based on commercial and economic
considerations. The court concluded that “themost sensible reading of the phrase ‘restored
to use’ . . . takes into account the cost andcommercial feasibility of restoration.”
Therefore, the appellate court remanded thecase so that the trial court could evaluate thecost of delaying slaughter to achieve expected
weight as compared to damages incurred byadhering to the scheduled lifespan.

Several months after the policy incepted,
Construction discovered that the same
employee had committed check theft and was
responsible for the missing $1 million. Basedon this discovery, Construction submitted aclaim to Federal, which denied coverage. An
Ohio federal district court ruled in Federal’sfavor, concluding that all loss caused by theemployee was a single loss under the policy
and that Construction was aware of the loss
before the policy’s inception date. The Sixth
Circuit affirmed, rejecting Construction’sargument that the Limits of Liability
provision operates only to cap covered losses
to the $1 million policy limit, rather thandefine whether the policy covers a loss.

All Loss Attributable to Employee
Misconduct Constitutes a Single
Loss, Outside the Scope of Policy
Period, Rules Sixth Circuit
The Sixth Circuit ruled that all loss caused by
one employee’s misconduct was a “single loss”
under an employee-theft policy and that there
was no coverage under the policy because
the employer had “discovered” the loss prior
to executing the insurance policy. Constr.
Contractors Emp’r Grp., LLC v. Federal Ins.
Co., 2016 WL 3675572 (6th Cir. July 11, 2016).
Construction Contractors provided payroll,
tax and other administrative services
to subscribing construction companies.
In 2012, various financial discrepancies
were discovered, leading to an internal
investigation. The investigation revealed thata particular employee had committed wire

Maryland Court Rules That Insurer
Must Defend Deceptive Marketing
Claims Against Career Colleges
A Maryland federal district court ruled thatan insurer was obligated to defend deceptive
marketing claims, finding that a professional
services exclusion did not apply and thata subpoena constituted a “claim.” Educ.
Affiliates Inc. v. Federal Ins. Co., 2016 WL
4059159 (D. Md. July 28, 2016).
The coverage dispute arose out of a federal
and state investigation of certain for-profit
educational institutions owned by Education
Affiliates. The colleges were also named as
defendants in private lawsuits brought byformer students. The complaints alleged thatthe colleges’ recruiters made various false
statements, including about the quality ofeducation and facilities. Education Affiliatessought a defense from Federal under a D&O
policy that covered wrongful acts during
the policy period. Federal denied coverageon the basis of a “Professional Services”
exclusion that barred coverage for claims
arising in connection “with the rendering of
8

. . . professional services for others.” The court
rejected this assertion and ruled that Federal
was obligated to defend.
The court ruled that the Professional Services
exclusion did not apply as a matter of law
because the “marketing of professional
services is not the rendering of professional
services.” The court explained that the “factthat the marketing relates to the professional
services to be rendered to others cannot be
said to conflate the two because, in light of thefact plaintiffs’ core business is the renderingof educational services to others, suchconflation would provide an ‘evisceration’of coverage.”
The court also ruled that a subpoena issued bya state Attorney General’s Office constitutes
a “claim” under the policy because it is a“written demand for . . . non-monetary relief.”
As discussed in our October 2013 Alert,
decisions addressing whether the issuanceof a subpoena or other agency investigative
measures constitute a claim turn primarily
on applicable policy language as well as theparticular factual record presented.

Ambiguity Alert:

Extrinsic Evidence Cannot Create
Policy Ambiguity, Says Colorado
Supreme Court
Reversing an appellate court decision,
the Colorado Supreme Court ruled thata policyholder may not rely on extrinsic
evidence to establish a policy ambiguity.
Rather extrinsic evidence may only be used todetermine the parties’ intent if an ambiguity
appears in the four corners of the document.
American Family Mutual Ins. Co. v. Hansen,
2016 WL 3398507 (Colo. June 20, 2016).
The coverage dispute arose out of a motor
vehicle accident, in which Jennifer Hansen
was injured. She filed a claim with American
Family under a policy that insured the car.
American Family denied the claim on thebasis that Hansen was not insured undera policy that listed Hansen’s mother andstepfather as named insureds. Hansen sued,
alleging breach of contract and statutory
and common law bad faith. In support of her
claims, she submitted lienholder statements
issued to her by American Family’s local

agent that identified her as a named insured
under the policy. A trial court ruled that thediscrepancy between the declaration page andlienholder statement created an ambiguity
which must be construed in Hansen’s favor. A
jury ruled in Hansen’s favor on the statutory
bad faith claim, finding that American Family
had denied payment without a reasonablebasis. An appellate court affirmed.
The Colorado Supreme Court reversed,
holding that because the policy listed only
two other individuals as named insureds at
the time of the accident, the trial court andappellate court erred in relying on extrinsic
evidence to find an ambiguity. The court
stated that “[a]n ambiguity must appear
in the four corners of the document before
an extrinsic evidence can be considered.”
Therefore, the court held that American
Family’s denial of Hansen’s claim in relianceon the unambiguous policy was reasonable
and it could not be found liable for statutory
bad faith. The court also rejected Hansen’s
reasonable expectations argument. Although
Colorado law has allowed the reasonable
expectations of an insured to “succeed[ ]over exclusionary policy language,” the court
deemed the doctrine inapplicable because
Hansen was not an insured under the policy.

Reinsurance
Alert:New York Court Addresses Late
Notice, Retention Warranty
and Follow the Fortunes In
Reinsurance Dispute
A New York trial court addressed arguments
relating to late notice, warranty of retention
and follow the fortunes in a reinsurance
coverage dispute. Granite State Ins. Co. v.
Clearwater Ins. Co., No. 653546/11 (N.Y.
Sup. Ct. New York Cnty. June 17, 2016).
Granite State issued an excess policy toKaiser Aluminum. The policy was reinsured
by Clearwater. When Kaiser was sued inthousands of personal injury asbestos-related
suits, litigation between Kaiser and various
insurers ensued. Granite State ultimately
reached a policy-limits settlement with Kaiser,
and Kaiser filed for Chapter 11 protection.
Four years after a bankruptcy court approved9

the settlement, Granite State billed reinsurer
Clearwater for the loss. Clearwater refused
to pay, arguing that Granite State knewthat the underlying policy limits would bereached years before it notified Clearwater,
and that Granite State’s delay in providing
notice violated the reinsurance certificate andsubstantially prejudiced Clearwater. A New
York trial court ruled in Granite State’s favor
on the late notice defense, and issued several
other rulings relating to interpretation ofClearwater’s reinsurance certificate.
First, the court held that Clearwater did
not waive its right to assert late noticenotwithstanding a two-year delay in denying
coverage on that basis. The court reasoned
that there was no evidence of misconduct
on Clearwater’s part, and that Granite State
failed to establish detrimental reliance basedon the delay.
Second, the court found an actual conflict
between New York and California law as towhether a reinsurer can obtain “constructive
notice” of a potential claim. Under New
York law, a cedent cannot contend thatits reinsurer obtained knowledge of aclaim through collateral sources, whereas
California law permits such constructive
notice. Applying California law (based on a“significant contacts” analysis), the court heldthat the record did not support a showing of
constructive notice to Clearwater. Althoughcertain documents evidenced Granite State’s
possible involvement in litigation, the court
agreed with Clearwater that “[p]roviding
general information about an underlying
policyholder, and hoping that the reinsurer‘figures it out,’ is not what the [Certificate]notice provision requires.”Third, the court held that California
law requires a showing of “actual andsubstantial” prejudice stemming from late
notice and that Clearwater failed to makesuch showing. Clearwater argued that it
had reached a commutation agreementwith a retrocessionaire, which it would nothave entered had it known about the Kaiser
reinsurance claim. Relying on Ninth Circuit
precedent, the court concluded that thecommutation agreement was a “collateralmatter” that did not establish prejudice.
Fourth, the court rejected Clearwater’s
exhaustion argument—i.e., that Granite State
did not “actually pay” settlement amounts to
Kaiser, as required by the certificates, because

payment was made by related entities rather
than Granite State itself. The court deemed
this argument “overly simplistic” and ruledthat Clearwater’s obligations were triggeredby virtue of the fact that payments were madeup to the limits of Granite State’s underlying
policy, regardless of the source of payments.
Fifth, the court ruled that a factual issue
existed as to whether Granite State’s
pooling agreement with other companies,
under which all of Granite State’s liability
was transferred violated the “warranty ofretention” provision in the reinsurance
certificate. The warranty of retention clauserequired Granite State to “retain for its own
account, subject to treaty insurance only, ifany, the amount specified on the face of th[e]Certificate.” The court explained that under
California law, evidence of custom and usage
can establish a latent ambiguity in otherwise
facially unambiguous policy language. The
court concluded that an ambiguity existed
here because an expert testified that an intercompany pooling agreement among affiliates
is not typically considered a violation of aretention warranty.

Finally, the court ruled that Clearwater wasentitled to challenge Granite State’s allocationof insurance proceeds to underlying claims.
In so ruling, the court held that a reinsurance
provision which states that Clearwater’sliability “shall follow [Granite State’s] liability
in accordance with the terms and conditionsof the policy reinsured hereunder,” was a“follow form” clause, and not a follow thefortunes provision. Although other courts
have reached a contrary conclusion when
faced with similar language, the Granite State
court “beg[ged] to differ.”
10

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This edition of the
Insurance Law Alert was
prepared by Mary Beth Forshaw
mforshaw@stblaw.com /+1-212455-2846 and Bryce L. Friedman
bfriedman@stblaw.com /+1-212-4552235 with contributions
by Karen Cestarikcestari@stblaw.com.

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