Insurance Law Alert

July/August 2020

In This Issue
Three Courts Reject Policyholders’ Bids For Business Interruption
Coverage, Citing Lack Of “Physical Loss Or Damage”“Skilled inhandling catastrophic
event liability issues andbad faith disputes, and acts
for an enviable client rosterof market-leading insurance
providers.”– Chambers USA
2020

Trial courts in the District of Columbia and Michigan and a federal district court in Texas
ruled that policyholders are not entitled to business interruption coverage stemming fromgovernment orders aimed at slowing the spread of COVID-19, finding that the insured
properties did not sustain any direct physical loss or damage, as required by the policies.
Rose’s 1, LLC v. Erie Ins. Exchange, No. 2020 CA 002424 (D.C. Superior Ct. Aug. 6,2020); Gavrilides Mgmt. Co. LLC v. Michigan Ins. Co., No. 20-258-CB-C30 (Mich. Cir.
Ct. Ingham Cty. July 2, 2020) (Oral Transcript); Diesel Barbershop, LLC v. State Farm
Lloyds, 2020 WL 4724305 (W.D. Tex. Aug. 13, 2020). (Click here for full article)

Two Courts Decline To Dismiss COVID-19 Coverage Claims
A Missouri federal district court and a New Jersey trial court declined to dismiss COVID19-related coverage suits against property insurers, finding that the allegations sufficiently
stated claims for coverage. Studio 417, Inc. v. The Cincinnati Ins. Co., 2020 WL 4692385(W.D. Mo. Aug. 12, 2020); Optical Services USA/JC1 v. Franklin Mutual Ins. Co., No.
BER-L-3681-20 (N.J. Super. Ct. Bergen Cty. Aug. 13, 2020) (Oral Transcript). (Click here
for full article)

New Jersey Supreme Court Rules That “Made Whole” Doctrine Does
Not Apply To Self-Insured Retention Or Deductible Payments
The New Jersey Supreme Court ruled that the made whole doctrine, under which an
insurer is not permitted to seek subrogation until the insured has been fully compensatedfor its loss, does not apply to self-insured retentions or deductible payments. City ofAsbury Park v. Star Ins. Co., 2020 WL 3493526 (N.J. June 29, 2020). (Click here forfull article)

Professional Services Exclusion Bars Coverage For Claims Alleging
Fake Lab Results, Says Kentucky Court
A Kentucky federal district court ruled that a professional services exclusion barred
coverage for a suit alleging that a laboratory reported false test results and that the insurer
had no duty to defend or indemnify the underlying claims. State Farm Fire and Casualty
Co. v. Compliance Advantage, LLC, 2020 WL 3800517 (E.D. Ky. July 7, 2020). (Click here
for full article)

Simpson Thacher & Bartlett LLP

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Reversing Trial Court, Illinois Appellate Court Enforces Assault And
Battery And Firearms Exclusions
An Illinois appellate court ruled that an insurer had no duty to defend an underlying suitbased on exclusions for assault and battery and firearms, and that the insurer was notestopped from denying coverage based on its refusal to defend. Markel Internat’l Ins. Co.
Ltd. v. Montgomery, 2020 WL 4333619 (July 24, 2020). (Click here for full article)

Seventh Circuit Rules That Damages Phase Of Underlying Litigation Is
Not A “Claim” Under Claims-Made Policy
The Seventh Circuit ruled that the “damages argument” in a trial of a thirteen-year old
suit against the policyholder is not a “claim” that triggered coverage under a claims-madepolicy. Market Street Bancshares, Inc. v. Federal Ins. Co., 962 F.3d 947 (7th Cir. 2020).
(Click here for full article)

Eleventh Circuit Rules That Sublimit Provision Precludes Coverage
Under Excess Policy
The Eleventh Circuit ruled that an excess insurer had no duty to provide coverage,finding that a sublimit provision in an excess policy unambiguously limited the applicablecoverage. Starstone National Ins. Co. v. Polynesian Inn, LLC, 2020 WL 3121299 (11th Cir.
June 12, 2020). (Click here for full article)

Reversing Trial Court, Ohio Appellate Court Endorses Vertical
Exhaustion For Triggering Excess Policies
An Ohio appellate court ruled that vertical exhaustion controls whether excess policies are
implicated and that only the primary policy directly underneath an excess policy must be
exhausted in order to trigger excess coverage. The William Powell Co. v. OneBeacon Ins.
Co., 2020 WL 3076571 (Ohio Ct. App. June 10, 2020). (Click here for full article)

Citing Recent Montrose Decision, California Appellate Court Vacates
Trial Court’s Horizontal Exhaustion Ruling
A California appellate court reversed a trial court decision that applied horizontal
exhaustion to determine excess insurers’ obligations, instead ruling that exhaustion of
only primary policies directly underneath an excess insurance policy is required in order
to trigger excess coverage. SantaFe Braun, Inc. v. Ins. Co. of N. Am., 52 Cal. App. 5th 19(2020). (Click here for full article)

Michigan Supreme Court Rules That Faulty Work Resulting In Damage
To Insured’s Work Product May Be Covered Under General Liability
PolicyThe Michigan Supreme Court ruled that faulty workmanship by a subcontractor may
constitute a covered “occurrence” under a general liability policy, even where it damages
only the insured’s work product. Skanska USA Building Inc. v. M.A.P. MechanicalContractors, Inc., 2020 WL 3527909 (Mich. June 29, 2020). (Click here for full article)2New Jersey Appellate Court Rules That Advertising Injury Coverage
Encompasses Copyright Infringement Claims
A New Jersey appellate court ruled that copyright infringement claims alleged covered“advertising injury,” triggering the insurer’s duty to defend. Superior Integrated
Solutions, Inc. v. Mercer Ins. Co. of N.J., No. A-1027-18T4 (N.J. App. Div. July 10, 2020).
(Click here for full article)

California Court Rules That Arbitration Agreement In Primary Policy
Does Not Require Excess Insurer To Arbitrate, Notwithstanding“Follow Form” Clause
A California federal district court denied a policyholder’s motion to compel arbitration,
ruling that an arbitration agreement in a primary policy was not incorporated in a “followform” excess policy in light of a conflicting “service of suit” clause in the excess policy.
Arch Specialty Ins. Co. v. University of Southern California, No. 19-cv-6964 (C.D. Cal.
July 20, 2020). (Click here for full article)

Illinois Appellate Court Rules That Insurer May Not Depreciate Labor
Costs In Calculating Actual Cash Value
An Illinois appellate court ruled that labor costs may not be depreciated in the actual cash
value calculation for property insurance. Sproull v. State Farm Fire & Cas. Co., 2020 WL
4251702 (Ill. Ct. App. July 24, 2020). (Click here for full article)

New York Department Of Financial Services Files First Cybersecurity
Enforcement Action Against Insurer
The New York Department of Financial Services filed its first action under the
cybersecurity regulations applicable to entities subject to New York banking, insurance
and financial services laws, N.Y. Comp. R. & Regs. Tit. 23 § 500 (2017). In the Matter of:First American Title Ins. Co., No. 2020-0030-C (N.Y. State Dep’t Fin. Servs. filed July 21,2020). (Click here for full article)

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COVID-19 Alerts:
Three Courts Reject Policyholders’Bids For Business Interruption
Coverage, Citing Lack Of “Physical
Loss Or Damage”
Trial courts in the District of Columbia
and Michigan ruled that restaurant owners
are not entitled to business interruption
coverage stemming from government orders
aimed at slowing the spread of COVID-19,
finding that the insured properties did notsustain any direct physical loss or damage, as
required by the policies. Rose’s 1, LLC v. ErieIns. Exchange, No. 2020 CA 002424 (D.C.
Superior Ct. Aug. 6, 2020); Gavrilides Mgmt.
Co. LLC v. Michigan Ins. Co., No. 20-258-CBC30 (Mich. Cir. Ct. Ingham Cty. July 2, 2020)(Oral Transcript).

In the Washington D.C. case, the court
granted the insurer’s summary judgment
motion, ruling that the policyholder is notentitled to business interruption coverage
for COVID-19-related loss. According to thepolicyholder’s statement of material facts,
the mayor of Washington D.C. declared astate of emergency, ordered the closure of
non-essential businesses and issued a stayat-home mandate that lasted several months.
The policyholder argued that as a result of
these orders, its restaurants were forced toclose and incurred significant revenue losses.
Erie Insurance denied coverage on the basisthat there was no “direct physical loss” toinsured property, as required by the policies.
Siding with Erie Insurance, the court rejected
the policyholder’s assertion that the loss
was “direct” because the restaurant closures
were the direct result of the mayor’s orders,
explaining that the orders “did not effectany direct changes to the properties.” Thecourt also dismissed the contention that theloss was physical because the COVID-19
virus is “material” and “tangible.” The courtemphasized that the policyholder “offer[ed]no evidence that COVID-19 was actuallypresent on their insured properties at thetime they were forced to close.” Therefore, thepolicyholder could not establish the requisitematerial or tangible change to property
under its own theory. Additionally, the court
rejected the policyholder’s attempt to equate“loss of use” with “direct physical loss,”
explaining that the latter requires a “direct
physical intrusion on to the insured property.”
The court distinguished several cases
frequently cited by policyholders in thiscontext, noting that none of them support
the proposition that a government edict,
standing alone, constitutes direct physicalloss under a property policy. See, e.g.,
Gregory Packaging, Inc. v. Travelers Prop.
Cas. Co. of Am, 2014 WL 6675934 (D.N.J.
Nov. 25, 2014) (ammonia leak that rendered
property unusable was a direct physical loss
because it constituted “an actual change ininsured property . . . causing it to become
unsatisfactory for future use or requiring that
repairs be made to make it so”); WesternFire Ins. Co. v. First Presbyterian Church.,
437 P.2d 52 (Colo. 1968) (direct physicalloss requirement satisfied by release ofgasoline fumes into church because building
became “infiltrated and saturated so as tobe uninhabitable”).
In the Michigan case, the policyholder sought
coverage for losses it allegedly sustained after
the Michigan governor issued an executive
order that limited the restaurants’ businessto take out and delivery. The policy provided
business interruption coverage for loss of
income due to a suspension of operations
caused by direct physical loss or damage toan insured property. In a ruling from thebench, the judge held that physical loss must
be tangible and alter the “physical integrityof the property.” Noting that the underlying
complaint did not allege any confirmed
cases of COVID-19 at the insured locations,the court concluded there was no physicaldamage to the insured’s property. The rulingsupports insurers’ contention that there is nocoverage for losses arising from limitations onaccess to premises due to COVID-19-related
government orders because the requisite
physical loss or damage is lacking.

4In addition, the court rejected thepolicyholder’s assertion that a virus exclusion
was ambiguous and inapplicable because
the losses were caused by an executive orderrather than the virus itself. The court heldthat even assuming that the loss stemmed
from government action rather than theactual virus, coverage would nonethelessbe barred by an exclusion relating to acts or
decisions of government entities.

While the Orders technically forced theProperties to close to protect public health,the Orders only came about sequentially asa result of the COVID-19 virus.” Finally, thecourt ruled that a civil authority provision was
inapplicable based on the lack of requisite
physical damage to neighboring property.

Employing similar reasoning, a Texas federal
district court dismissed several barbershops’
COVID-19-related coverage claims in Diesel
Barbershop, LLC v. State Farm Lloyds, No.
5:20-CV-461 (W.D. Tex. Aug. 13, 2020). The
court ruled that the policyholders failed toallege direct physical loss to insured property.
The court acknowledged that some courts
have found physical loss absent tangible
destruction in other contexts, but deemed

In contrast to the rulings discussed above,a Missouri federal district court declined todismiss a COVID-19-related coverage suitagainst a property insurer, finding that theallegations sufficiently stated claims forcoverage under several policy provisions.
Studio 417, Inc. v. The Cincinnati Ins. Co.,
2020 WL 4692385 (W.D. Mo. Aug. 12, 2020).

those cases distinguishable, concluding that“the line of cases requiring tangible injury
to property are more persuasive here.” In
addition, the court held that even if thepolicyholders had alleged direct physicalloss, coverage would be barred by a virus
exclusion. In so ruling, the court rejected thepolicyholders’ assertion that the exclusion
did not apply because the losses were causedby government orders, rather than presenceof the virus itself. The policyholders also
argued that an anti-concurrent causation
clause, which operated as a “lead-in” tothe virus exclusion and barred coveragefor excluded events “regardless of . . othercauses of the loss; or . . . whether othercauses acted concurrently or in any sequencewith the excluded event to produce theloss,” was ambiguous. The court rejected
this contention, stating that “Plaintiffs
have pleaded that COVID-19 is in fact thereason for the Orders being issued and theunderlying cause of Plaintiffs’ alleged losses.

Two Courts Decline To Dismiss
COVID-19 Coverage Claims

Hair salons and restaurants sought coverage
under policies that covered “accidental[direct] physical loss or accidental [direct]
physical damage,” unless otherwise excluded.
The policies did not define physical loss
or physical damage and did not include aviral or communicable disease exclusion.
The court concluded that the policyholders
adequately alleged a direct physical loss
because the complaint alleged that COVID-19“is a physical substance” that “live[d] on” andwas “active on inert physical surfaces” and“attached to and deprived Plaintiffs of theirproperty, making it ‘unsafe and unusable.’”The court emphasized that the policy
covered physical loss or physical damage andreasoned that it “must give meaning to bothterms.” The court noted that in other cases,
courts have required a “tangible alteration” inorder to establish physical loss, but explainedthat those cases were decided on summary
judgment or were factually distinguishable.
Here, on the insurer’s motion to dismiss,the court accepted as true the policyholders’assertion that the virus is a physical substancethat was likely on their premises and caused
them to suspend operations.
Based on the same reasoning, the court
declined to dismiss coverage claims
pursuant to provisions for civil authority
coverage, ingress and egress coverage,
dependent property coverage, and sue andlabor coverage.
A New Jersey trial court also denied aninsurer’s motion to dismiss COVID-19related coverage claims, citing the lack5

of legal authority in this context and theabsence of a developed factual record. Optical
Services USA/JC1 v. Franklin Mutual Ins.
Co., No. BER-L-3681-20 (N.J. Super. Ct.
Bergen Cty. Aug. 13, 2020) (Oral Transcript).
There, the operative policy covered businessinterruption losses resulting from directcovered loss, defined as “the fortuitous direct
physical loss as described in Part 1(c).” The
policy further stated that covered loss means“fortuitous direct physical damage to or
destruction of covered property by a covered
cause of loss.” The insurer argued that thecomplaint failed to allege direct physicaldamage because it expressly admitted that“there is no known instance of COVID19 transmission or contamination within
the premises of plaintiffs’ businesses.”
In contrast, the policyholders contended
that the loss of “physical functionality andthe use of their business” by virtue of thegovernment mandates constitutes a covered
loss. Declining to rule as a matter of law, thecourt noted the lack of controlling New Jersey
authority in this context and the absenceof discovery in this matter. The insurer did
not contend that a virus exclusion in thepolicy applied.

Subrogation Alert:
New Jersey Supreme Court Rules
That “Made Whole” Doctrine
Does Not Apply To Self-Insured
Retention Or Deductible Payments

amount of its self-insured retention) and Star
Insurance paid an additional $2.6 million.
After a third-party tortfeasor paid the injured
employee additional amounts, the City andStar Insurance sought reimbursement ofamounts paid to the employee. The question
before the court was whether, under themade whole doctrine, the City had priority torecover its self-insured retention before Star
Insurance could recover any of its payments.
The New Jersey Supreme Court, answering
a question certified by the Third Circuit,ruled that the made whole doctrine does not
apply “to first-dollar risk that is allocated to
an insured under an insurance policy, i.e.,a self-insured retention or deductible.” Thecourt explained that such payments reflectrisk that the insured agreed to assume inexchange for a reduced premium. Therefore,prioritizing reimbursement of a self-insured
retention over an insurer’s loss “would, in
effect, convert the policy into one without aself-insured retention.”As the court noted, the Supreme Courts ofConnecticut and Pennsylvania have reachedsimilar conclusions, whereas the Supreme
Court of Washington ruled that a first-party
insurer, upon receiving partial recovery
through subrogation, was obligated toreimburse its “fault-free insureds for the fullamount of their deductible before any portionof the subrogation proceeds can be allocatedto the insurer.”

Addressing a matter of first impression under
New Jersey law, the New Jersey Supreme
Court ruled that the made whole doctrine,
under which an insurer is not permitted toseek subrogation until the insured has been
fully compensated for its loss, does not apply
to self-insured retentions or deductible
payments. City of Asbury Park v. Star Ins.
Co., 2020 WL 3493526 (N.J. June 29, 2020).
Star Insurance provided workers
compensation coverage to the City of Asbury.
The policy included a self-insured retentionof $400,000 per occurrence, as well as a
subrogation provision that allowed Star
Insurance to be subrogated to the City’s rights
after payment is made under the insurance
contract. When a City employee was injured,
the City paid the employee $400,000 (the full6

Coverage Alerts:
Professional Services Exclusion
Bars Coverage For Claims Alleging
Fake Lab Results, Says Kentucky
Court
A Kentucky federal district court ruled thata professional services exclusion barred
coverage for a suit alleging that a laboratory
reported false test results and that theinsurer had no duty to defend or indemnify
the underlying claims. State Farm Fire andCasualty Co. v. Compliance Advantage, LLC,
2020 WL 3800517 (E.D. Ky. July 7, 2020).
The underlying suit alleged that the laboratory
reported false results to government agencies
that led to the plaintiff’s loss of child custody.
State Farm sought a declaration that it had
no duty to defend or indemnify the suitbased on a professional services exclusion,
which applied to injury or damage “arisingout of the rendering or failure to renderany professional service or treatment,”
including but not limited to “treatment,
advice or instruction of any medical, surgical,
dental, x-ray or nursing services.” The court
concluded that the underlying claims, basedon the laboratory’s taking of samples andtransmission of results to third-parties, fellsquarely within the exclusion. The court
rejected the laboratory’s counter-assertion
that the loss resulted from equipment
malfunction or other “ministerial conduct”
rather than the provision of professional
services. The court explained that Kentucky
law interprets “arising out of” expansively tomean “originating from,” “growing out of” or“flowing from,” such that “all that is required
is some causal connection.”

Reversing Trial Court, Illinois
Appellate Court Enforces Assault
And Battery And Firearms
Exclusions
An Illinois appellate court ruled that aninsurer had no duty to defend an underlying
suit based on exclusions for assault andbattery and firearms, and that the insurer was
not estopped from denying coverage based on
its refusal to defend. Markel Internat’l Ins.
Co. Ltd. v. Montgomery, 2020 WL 4333619(July 24, 2020).
The underlying complaint against a bar,its owner and security guard, and two
assailants (collectively, the “Defendants”)
sought damages for the death of a patronand serious injuries to another. Markel
disclaimed coverage based on exclusions
relating to assault and battery, firearms andliquor liability. Thereafter, Markel soughta declaration that it had no duty to defend
or indemnify the claims. The Defendantscounterclaimed, alleging breach of contract,
bad faith and coverage by estoppel. An
Illinois trial court ruled in the Defendants’favor, finding that the complaint asserted aclaim that potentially fell within the scopeof coverage and that Markel’s denial was
vexatious and unreasonable under Illinois
statutory law. The trial court also ruled thatMarkel was estopped from asserting defenses
under the policy and was obligated to pay theunderlying default judgment.
The appellate court reversed, ruling thatMarkel had no duty to defend and was notestopped from denying coverage. The court
reasoned that all of the underlying claims“arose out of” assault and battery and/or use

7

of a firearm. The court deemed it irrelevantthat the underlying complaint alleged
negligence, explaining that “the alleged
negligence is inseparable from the assault andbattery and the use of a firearm . . . regardlessof how the causes of action were pleaded.”
Additionally, the appellate court rejected thetrial court’s estoppel ruling. Under Illinois
law, estoppel applies only when an insurer
has breached its duty to defend. However,
estoppel does not apply where, as here, theinsurer’s defense obligation was not triggeredin the first instance.

Seventh Circuit Rules That
Damages Phase Of Underlying
Litigation Is Not A “Claim” Under
Claims-Made Policy

the bank’s assertion that the underlying
damages assertion was “a written demand formonetary relief,” finding instead that it was
merely a part of the civil action that began in
2003. The court deemed it irrelevant that thedamages argument went beyond the scope ofthe original legal theories and facts alleged in
the underlying complaint, explaining that theoperative question is how the policy defines“claim,” “not where the causes of action ina lawsuit begin and end.” The court stated:“reading a ‘civil proceeding’ as spanningless than the complete civil action opens thedoor to a single action between two parties
encompassing multiple ‘claims,’ which would
defeat the purpose of making the insurer’s
risk exposure easy to identify.”

The Seventh Circuit ruled that the “damages
argument” in a trial of a thirteen-year old
suit against the policyholder is not a “claim”
that triggered coverage under a claimsmade policy. Market Street Bancshares,
Inc. v. Federal Ins. Co., 962 F.3d 947 (7thCir. 2020).
In 2003, Peoples National Bank was sued inconnection with a failed business deal. Nine
years later, a court entered judgment against
the bank on one claim. In 2014, the bankobtained a professional liability policy fromFederal Insurance. The claims-made policy,
in effect from 2014 to 2017, defined “claim”
as “a written demand for monetary or nonmonetary relief . . . [or] a civil proceeding
commenced by the service of a complaint orsimilar pleading.” It further provided that aclaim “will be deemed to have first been madewhen such Claim is commenced as set forthin this definition.” In 2015, the court granted
summary judgment to the underlying plaintiff
on the remaining claims against the bank, andin 2016, the underlying suit went to trial on
damages. The bank notified Federal Insuranceof the damages trial, taking the position thatit gave rise to a “claim” under the policy.
Federal denied coverage. In ensuing coveragelitigation, an Illinois federal district court
granted Federal’s summary judgment motion
and the Seventh Circuit affirmed.
The Seventh Circuit ruled that the underlying“damages assertion—advanced about thirteen
years into the lawsuit—” did not constitute a“claim” that triggered Federal’s defense andindemnity obligations. The court rejected

Excess Alerts:
Eleventh Circuit Rules That
Sublimit Provision Precludes
Coverage Under Excess Policy
The Eleventh Circuit ruled that an excess
insurer had no duty to provide coverage,finding that a sublimit provision in an excess
policy unambiguously limited the applicablecoverage. Starstone National Ins. Co. v.
Polynesian Inn, LLC, 2020 WL 3121299 (11thCir. June 12, 2020).
The coverage dispute arose out of a physicalassault at a hotel. The hotel’s primary
insurance policy provided $1 million in
liability coverage per-occurrence. It also
included a “Limited Assault or Battery
Liability Coverage” endorsement that madeavailable separate coverage for bodily injury
caused by assault or battery, subject to a
$25,000 per-occurrence limit. The excess8policy followed form to the primary policy andprovided coverage in excess of the primarypolicy’s “Total Limits” – a list that included
the $1 million per-occurrence limit. However,
the excess policy explicitly excluded coverage
for any “[s]ublimit of liability, unless coveragefor such sublimit is specifically endorsed to
the Policy.” The parties disputed whether the$25,000 per-occurrence limit for assault andbattery injuries was a “sublimit” under theexcess policy.

The court ruled that the assault and battery
endorsement established a “sublimit” suchthat excess coverage was not implicated.
Although “sublimit” was not defined in
the policy, the court reasoned that the$25,000 per-occurrence limit for assault
and battery injuries constituted a sublimit
because it “caps the insurer’s exposure at an
amount below the ordinary policy limit for a
subcategory of loss.” The court rejected thehotel’s assertion that the endorsement createda “standalone limit” (rather than a sublimit)
because it existed “apart from” and “notunder or subordinate to the $1 million peroccurrence limit.”

Reversing Trial Court, Ohio
Appellate Court Endorses Vertical
Exhaustion For Triggering Excess
Policies
An Ohio appellate court ruled that verticalexhaustion controls whether excess policies
are implicated and that only the primarypolicy directly underneath an excess policy
must be exhausted in order to trigger
excess coverage. The William Powell Co. v.
OneBeacon Ins. Co., 2020 WL 3076571 (OhioCt. App. June 10, 2020).

The coverage dispute arose out of thousandsof asbestos-related bodily injury claims
against Powell. In a previous ruling, theappellate court applied a “triggering-event”
theory and held that each exposure toasbestos constitutes a separate occurrence.
See January 2017 Alert. Thereafter, an Ohio
trial court held a bench trial on remaining
issues and concluded that horizontal
exhaustion applies, such that all triggered
primary policies must be exhausted before
excess coverage is available. The appellate
court reversed.
Although the terms of OneBeacon’s andFederal’s excess policies varied somewhat,
each provided indemnification for sums
that Powell became legally obligated to pay“in excess of the insured’s retained limits.”
Retained limits was defined as “the totalof the applicable limits of liability of theunderlying insurance as set forth in Schedule
A hereof, plus the applicable limits of any
other underlying insurance collectible by the
insured.” The court deemed this language,
when read together with other policy
provisions, as unambiguously requiring
vertical exhaustion. The court explained thatvertical exhaustion is:reflected in OneBeacon’s policies’
definition of the term “underlying
insurance” (“collectible insurance withany other insurer [ ] available to theinsured covering a loss also covered
hereunder”) and Federal’s policy
provision regarding “Other Insurance”(“any other insurance [ ] available to theinsured covering a loss also coveredby this policy”). . . . Thus, underlying
insurance–insurance available to covera loss also covered by the excess policy–
must also be insurance covering an
occurrence during the policy period.
In other words, the policy language
reveals that “underlying insurance”“refers only to policies covering thesame risk, such as concurrent policies.”
Prior and subsequent policies, on theother hand, insure against different
risks in different time periods.
Ruling on a separate issue, the court endorsed
an “all sums” allocation, under which Powellis entitled to choose one insurer to indemnify
all costs incurred during the period ofcontinuous injury.
9Citing Recent Montrose Decision,
California Appellate Court Vacates
Trial Court’s Horizontal Exhaustion
RulingOur April 2020 Alert reported on the
California Supreme Court’s decision inMontrose Chem. Corp. of Ca. v. Superior
Court of Los Angeles Cty., 2020 WL 1671560(Cal. Apr. 6, 2020), which held that applicablepolicy language entitled the policyholder toaccess coverage under a higher level policy
once it had exhausted directly underlying
excess policies for the same policy period, anddid not require exhaustion of every lower level
excess policy during the relevant time frame.
Last month, a California appellate court,
citing Montrose, reversed a trial court
decision that applied horizontal exhaustion
to determine excess insurers’ obligations.
SantaFe Braun, Inc. v. Ins. Co. of N. Am.,
52 Cal. App. 5th 19 (2020). The appellate
court concluded that exhaustion of only
primary policies directly underneath anexcess insurance policy is required in order totrigger excess coverage. Noting that the policy
language at issue was comparable to that inMontrose, the court stated that “[t]he ‘otherinsurance’ clauses are similarly ambiguous
and the ‘other aspects of the insurance
policies’ including the scheduling of theapplicable primary policies and definitionsof ultimate net loss suggest ‘the exhaustion
requirements were meant to apply to directly
underlying insurance and not to insurance
purchased for other policy periods.’” Thecourt declined to rule on the rights of excess
carriers to seek contribution from primary
insurers whose policies do not directly
underlie the excess policies.

FaultyWorkmanship
Alert:
Michigan Supreme Court Rules
That Faulty Work Resulting In
Damage To Insured’s Work Product
May Be Covered Under General
Liability Policy
Reversing an appellate court, the Michigan
Supreme Court ruled that faulty workmanshipby a subcontractor may constitute a covered“occurrence” under a general liability policy,
even where it damages only the insured’s
work product. Skanska USA Building Inc. v.
M.A.P. Mechanical Contractors, Inc., 2020
WL 3527909 (Mich. June 29, 2020).
Skanska, the construction manager ona renovation project, used MAP as a
subcontractor for heating and cooling work.
MAP obtained a general liability policy
from Amerisure, which listed Skanska asan additional insured. A few years after
construction was complete, it was discoveredthat MAP had installed expansion joints
backward, resulting in significant damage
to the heating system. After repairing thedamage, Skanska sought coverage from
Amerisure. The insurer denied coverage,
stating that there had been no covered“occurrence” under the policy.
A Michigan trial court denied the insurer’ssummary judgment motion, finding thatan occurrence “may have happened”
because MAP did not purposefully install
the expansion joints backward. The trial
court further held that although faulty
workmanship “standing alone” does notconstitute a covered occurrence, there may
be a potential occurrence where damage
goes beyond the scope of the insured’s own
work. An appellate court reversed, granting
summary judgment to Amerisure andfinding that there is no occurrence where, as
here, the only damage was to the insured’s
own work product. The Michigan Supreme
Court reversed.
The Michigan Supreme Court noted thatwhile the policy contained an exclusion
barring coverage for an insured’s own
work product, there was an exception to10

the exclusion for work performed by asubcontractor. The court explained: “If faulty
workmanship by a subcontractor could neverconstitute an ‘accident’ and therefore never bean ‘occurrence’ triggering coverage in the firstplace, the subcontractor exception would benugatory.” Moreover, the court emphasized
the lack of support for the appellate court’s
ruling that “accident” cannot include damage
limited to the insured’s own work product.
Finally, the court distinguished HawkeyeSecurity Ins. Co. v. Vector Constru. Co.,
185 Mich. App. 369 (1990), in which thecourt held that damage to an insured’s own
work due to faulty construction is not an“occurrence.” The court noted that Hawkeye
involved a 1973 policy with different language
and presented the question of whether aninsurer owed coverage to a general contractor
for damages resulting from its own defective
work, not the work of a subcontractor.

Advertising Injury
Alert:New Jersey Appellate Court
Rules That Advertising Injury
Coverage Encompasses Copyright
Infringement Claims
A New Jersey appellate court ruled thatcopyright infringement claims alleged
covered “advertising injury,” triggering theinsurer’s duty to defend. Superior Integrated
Solutions, Inc. v. Mercer Ins. Co. of N.J., No.
A-1027-18T4 (N.J. App. Div. July 10, 2020).
Superior, a software application developer,
was sued by a competitor for copyright
infringement of a computer program usedby car dealerships. The complaint allegedthat Superior made an unauthorized copy ofa file and actively solicited customers to use
Superior’s services, resulting in substantial
harm to the competitor. Superior sought
coverage under a provision that covered“Advertising Injury arising out of an offense
committed in the course of advertising
goods, products, or services of your business/
operations.” Mercer Insurance refused todefend, citing several policy exclusions. A
New Jersey trial court granted Superior’s
summary judgment motion, ruling thatthe underlying complaint alleged covered

advertising injury and that none of the
exclusions barred coverage. The appellate
court affirmed.
The court rejected Mercer Insurance’s
assertion that there was no coverage because
Superior never engaged in “advertising”
and instead only engaged in “selling” ofits services through use of a competitor’s
copyrighted program. The court explainedthat the underlying allegation that Superior“profited from its theft of [a competitor’s][copyrighted] intellectual property by selling
integration services made possible only by
its copy infringement” alleged a claim ofadvertising activity. The court also rejected
the contention that the infringement mustoccur within an advertisement itself.

Arbitration Alert:
California Court Rules That
Arbitration Agreement In
Primary Policy Does Not Require
Excess Insurer To Arbitrate,
Notwithstanding “Follow Form”
ClauseA California federal district court denied apolicyholder’s motion to compel arbitration,
ruling that an arbitration agreement in a
primary policy was not incorporated ina “follow form” excess policy in light of aconflicting “service of suit” clause in theexcess policy. Arch Specialty Ins. Co. v.
University of Southern California, No. 19-cv6964 (C.D. Cal. July 20, 2020).
Arch Specialty issued excess policies to USC
that followed form to lower level excess
policies issued by Ironshore. Ironshore’s
policies, in turn, followed form to primarypolicies issued by BETA. When a dispute
regarding Arch’s duty to cover underlying
claims against USC arose, USC moved tocompel arbitration. USC argued that theArch policies incorporated the arbitrationagreement included in the BETA policies byvirtue of the “follow form” clauses in the ArchSpecialty and Ironshore excess policies. The
court disagreed.
Arch Specialty’s follow form clauseincorporated the provisions of underlying
insurance “except for . . . [a]ny otherprovision inconsistent with this coverage.”
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The court concluded that a service of suitendorsement in Arch Specialty’s policy wasinconsistent with the arbitration provisionin BETA’s policy. The service of suitendorsement requires the insurer to “submit
to the jurisdiction of any court of competentjurisdiction within the United States” andprovides that “[a]ll matters arising under thisPolicy shall be determined in accordance withthe law and practice of such Court.” Noting
the breadth of both the BETA arbitration
clause (which applies to “[a]ll disputes
in any way concerning, arising out of or
relating to this Contract”) and the service ofsuit endorsement, the court deemed theminconsistent and in conflict.
The court distinguished case law holdingthat a service of suit clause and arbitration
provision can be read together in a mannerthat allows a party to enforce arbitration
in a court of law. As the court noted, thosedecisions involved differently-worded
service of suit and arbitration clauses, ora single policy that included both clauses,
whereas here, the excess policy prioritized
its terms over inconsistent terms in anunderlying policy.

Property Insurance
Alert:
Illinois Appellate Court Rules That
Insurer May Not Depreciate Labor
Costs In Calculating Actual CashValue
As discussed in previous Alerts, the highest
courts of several states, and appellate courts
in many others, have ruled on whether
an insurer may depreciate labor costs in
calculating actual cash value (“ACV”).
See March and April 2020 Alerts; April
2019 Alert; March 2017 Alert; January
and February 2016 Alerts. Outcomes haveturned largely on policy language, as wellas governing jurisdictional law and public
policy considerations. Last month, an Illinois
appellate court weighed in, ruling that laborcosts may not be depreciated in the ACV
calculation. Sproull v. State Farm Fire &Cas. Co., 2020 WL 4251702 (Ill. Ct. App. July24, 2020).

The State Farm policy stated that “we will pay
only the actual cash value at the time of theloss of the damaged part of the property, up to
the applicable limit of liability.” The policy did
not define ACV or explain how it is calculated,
nor did it indicate that costs are subject todepreciation. When State Farm depreciatedboth labor and materials in calculating ACV
payment, the policyholder filed a putativeclass action, alleging breach of contract anddeceptive business practices. An Illinois trial
court denied State Farm’s motion to dismiss.
The trial court noted the lack of Illinois caselaw and the jurisdictional split on this issue,
and ultimately concluded that ACV wasambiguous and should be construed in thepolicyholder’s favor. In so ruling, the trial
court rejected State Farm’s argument that
Illinois statutory law, which states that themethod for calculating ACV is “replacement
cost of property at time of loss lessdepreciation, if any,” permits depreciation ofboth labor and materials. 50 Ill. Adm. Code919.80 (d)(8)(A) (2002). Thereafter, the trial
court certified the following question to theappellate court:
Where Illinois’ insurance regulations
provide that the “actual cash value”
or “ACV” of an insured, damaged
structure is determined as “replacement
cost of property at time of loss lessdepreciation, if any,” and the policy
does not itself define actual cash
value, may the insurer depreciate
all components of replacement cost(including labor) in calculating ACV?”
The appellate court answered the question in
the negative. The court reasoned the phrase“replacement cost of property” refers to “realproperty–an asset that can lose value overtime due to wear and deterioration, resulting
from use or the elements, and does not refer12to services, such as labor.” In so ruling, thecourt noted that an average, reasonable
person would expect that depreciation would
apply only to physical property and materials,
and not to labor services.

Regulatory Alert:
New York Department Of Financial
Services Files First Cybersecurity
Enforcement Action Against
Insurer
As discussed in our April 2019 and May
2018 Alerts, the New York Department of
Financial Services enacted cybersecurity
regulations applicable to entities subject to
New York banking, insurance and financial
services laws. The regulations impose certain
minimum requirements for cybersecurity
practices, including the maintenance of acybersecurity program and response plan,the designation of a senior officer to oversee
cybersecurity, routine risk assessment,

notification of a security incident to the
Department and annual compliancecertification. See N.Y. Comp. R. & Regs. Tit.
23 § 500 (2017).
This month, the Department filed its
first action under the regulations against
First American Title Insurance Company,
alleging failures relating to the company’s
information systems which led to a data
breach involving customers’ personal
information. In the Matter of: First American
Title Ins. Co., No. 2020-0030-C (N.Y.
State Dep’t Fin. Servs. filed July 21, 2020).
The filing alleges that from October 2014
through May 2019, customers’ bank accountinformation, mortgage and tax records andsocial security numbers were available on
the insurer’s public website due to a known
vulnerability in its computer system. The
Department claims that First American failed
to conduct appropriate security reviews
and risk assessments and misclassified thevulnerability as “low,” among other things.
Although First American confirmed thebreach, it has denied the charges. A hearing inthis matter is scheduled for October 26, 2020.

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Simpson Thacher has been an international leader in the practice of insurance and reinsurance law for
more than a quarter of a century. Our insurance litigation team practices worldwide.

Mary Beth Forshaw+1-212-455-2846
mforshaw@stblaw.com

Michael J. Garvey+1-212-455-7358
mgarvey@stblaw.com

Elisa Alcabes+1-212-455-3133
ealcabes@stblaw.com

Andrew T. Frankel+1-212-455-3073
afrankel@stblaw.com

Tyler B. Robinson+44-(0)20-7275-6118
trobinson@stblaw.com

Summer Craig+1-212-455-3881
scraig@stblaw.com

Lynn K. Neuner+1-212-455-2696
lneuner@stblaw.com

George S. Wang
+1-212-455-2228
gwang@stblaw.com

Jonathan T. Menitove+1-212-455-2693
jonathan.menitove@stblaw.com

Chet A. Kronenberg+1-310-407-7557
ckronenberg@stblaw.com

Craig S. Waldman+1-212-455-2881
cwaldman@stblaw.com

Isaac M. Rethy+1-212-455-3869
irethy@stblaw.com

Bryce L. Friedman+1-212-455-2235
bfriedman@stblaw.com

Susannah S. Geltman+1-212-455-2762
sgeltman@stblaw.com

This edition of the
Insurance Law Alert was
prepared by Mary Beth Forshaw
mforshaw@stblaw.com /+1-212-4552846 and Bryce L. Friedman
bfriedman@stblaw.com /+1-212-4552235 with contributions
by Karen Cestarikcestari@stblaw.com.

The contents of this publication are for informational purposes only. Neither this publication nor the
lawyers who authored it are rendering legal or other professional advice or opinions on specific facts
or matters, nor does the distribution of this publication to any person constitute the establishment of an
attorney-client relationship. Simpson Thacher & Bartlett LLP assumes no liability in connection withthe use of this publication. Please contact your relationship partner if we can be of assistance regardingthese important developments. The names and office locations of all of our partners, as well as ourrecent memoranda, can be obtained from our website, www.simpsonthacher.com.
Please click here to subscribe to the Insurance Law Alert.
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