Insurance Law Alert

November 2016

In This Issue
Fifth Circuit Rules That Computer Fraud Provision Does Not Encompass
Fraudulently-Induced Wire Transfer Claims
The Fifth Circuit ruled that a computer fraud provision does not grant coverage for claims
arising out the transfer of funds to criminal accounts because a fraudulent email was only one
part of a chain of events that caused the loss. Apache Corp. v. Great American Ins. Co., 2016
WL 6090901 (5th Cir. Oct. 18, 2016). (click here for full article)“Simpson Thacher
has many litigators
who are very experienced
in handling complex,
multi-faceted litigation
involving novel issues.”–Benchmark 2017,
quoting a client

Alabama Court Finds That Insurer Has No Duty To Defend Or Indemnify
Data Breach Suit
An Alabama federal district court ruled that an insurance policy does not cover claims alleging
that the policyholder’s negligence contributed to a data breach that caused financial loss.
Camp’s Grocery, Inc. v. State Farm Fire & Casualty Co., 2016 WL 6217161 (N.D. Ala. Oct. 25,
2016). (click here for full article)

Delaware Court Rules That Settlement Payments Are Not Uninsurable
Disgorgement
A Delaware trial court ruled that class action settlement payments do not constituteuninsurable disgorgement under New York law. TIAA-CREF Individual & Institutional Svs.,
LLC v. Illinois Nat’l Ins. Co., 2016 WL 6534271 (Del. Superior Ct. Oct. 20, 2016).
(click here for full article)

Alabama Court Addresses Pollution Exclusion And Timing Of Injury For
Sewage-Related Claims
An Alabama federal district court ruled that an absolute pollution exclusion does not bar
coverage for claims arising out of sewage exposure and that the date of injury is determinative
for purposes of policy period analysis, not the date of the injury-causing “occurrence.”
Evanston Ins. Co. v. J&J Cable Construction, LLC, 2016 WL 5346079 (M.D. Ala. Sept. 22,2016). (click here for full article)

Finding The Phrase “Arising Out Of” Ambiguous, Massachusetts Court
Orders Insurer To Defend Cosby Defamation Suit
A Massachusetts federal district court ruled that language in a sexual misconduct policy
exclusion was ambiguous and that the insurer was therefore obligated to defend defamation
claims related to sexual misconduct allegations. AIG Prop. Cas. Co. v. Green, 2016
WL 6637694 (D. Mass. Nov. 8, 2016). (click here for full article)

Simpson Thacher & Bartlett LLP

1

California Court Rejects Conflict of Interest And Untimely Defense
Arguments
A California federal district court ruled that an insurer did not breach its duty to defend andwas not required to hire independent counsel to defend the policyholder because no conflictof interest existed. St. Paul Mercury Ins. Co. v. McMillin Homes Construction, Inc., 2016
WL 5464533 (S.D. Cal. Sept. 29, 2016). (click here for full article)

Third Circuit Holds That Parties Should Arbitrate Reinsurance Dispute
And That Panel Should Determine Applicability of Nebraska’s AntiArbitration Statute
The Third Circuit granted a motion to compel arbitration, finding that an arbitrator, rather
than a court, should address challenges to the arbitration agreement and the applicability of a
Nebraska statute barring arbitration of insurance disputes. South Jersey Sanitation Co., Inc.
v. Applied Underwriters Captive Risk Assurance Co., 840 F.3d 138 (3d Cir. 2016).
(click here for full article)

Tennessee Court Denies Motion to Compel Information Relating To Other
Insurance Claims, Claims-Handling and Reinsurance Communications
A Tennessee federal district court denied policyholders’ motion to compel the production of
information relating to other insurance claims, claims handing, underwriting, loss reserves
and reinsurance communications. First Horizon Nat’l Corp. v. Houston Cas. Co., 2016 WL
5869580 (W.D. Tenn. Oct. 5, 2016). (click here for full article)2

Apache sought coverage from Great
Data Breach Alerts: criminals.
American, which denied coverage on theFifth Circuit Rules That Computer
Fraud Provision Does Not
Encompass Fraudulently-Induced
Wire Transfer Claims

ground that the loss did not “result[ ]directly from the use of a computer,” asrequired by the policy. A Texas district court
disagreed and ruled in favor of Apache. The
Fifth Circuit reversed.

The Fifth Circuit ruled that a computer fraud
provision does not grant coverage for claims
arising out the transfer of funds to criminal
accounts because a fraudulent email was
only one part of a chain of events that caused
the loss. Apache Corp. v. Great AmericanIns. Co., 2016 WL 6090901 (5th Cir. Oct.
18, 2016).

Addressing this matter of first impression
under Texas law, the Fifth Circuit ruled thatthe computer fraud provision did not cover
Apache’s claims because the loss resulted
from a series of events and was not “directly”
caused by computer use. In particular, thecourt explained that there was no coverageobligation because the wire transfers resulted
from the criminals’ initial phone call, thesubsequent phone call to the fraudulent
phone number, and Apache’s insufficientinternal controls for account changes. The
court stated:
The email was part of the scheme; but,the email was merely incidental to theoccurrence of the authorized transfer
of money. To interpret the computerfraud provision as reaching any
fraudulent scheme in which an emailcommunication was part of the process,would . . . convert the computer-fraud
provision to one for general fraud.

Apache, an oil production company, received
a telephone call from a person identifying
herself as a Petrofac representative (a vendor
for Apache). The caller instructed Apache tochange bank account information for future
payments. The Apache employee replied thatthe change could not be processed without
a formal request on Petrofac letterhead.
Thereafter, Apache received an email from anemail address created by criminals to closely
resemble Petrofac’s actual email address. The
email attached a letter confirming the request
to change the bank account on fraudulentlycreated letterhead. Apache called thetelephone number provided in the letter toconfirm the change and then approved thechange. After nearly $7 million was paid to
the new bank account, Apache discoveredthat the phone call and email came fromAs the Fifth Circuit noted, courts in otherjurisdictions have concluded that computer
fraud provisions have limited application andapply to claims arising directly out of use of
a computer (such as hacking) and not claims
that merely involve use of a computer at somepoint in the transaction.

Alabama Court Finds That Insurer
Has No Duty To Defend Or
Indemnify Data Breach Suit
An Alabama federal district court ruled thatan insurance policy does not provide coveragefor claims alleging that the policyholder’snegligence contributed to a data breach thatcaused financial loss. Camp’s Grocery, Inc.
v. State Farm Fire & Casualty Co., 2016 WL
6217161 (N.D. Ala. Oct. 25, 2016).
Hackers accessed the computer networkof Camp’s Grocery Store and gained accessto confidential customer data. Three credit
unions sued Camp’s, alleging that it was
liable for resulting losses based on its failure3

to provide adequate computer training toemployees and/or to maintain appropriate
security systems. Camp’s sued State Farmseeking a declaration that the insurer was
obligated to defend and indemnify thecredit unions’ claims. The court disagreed
and granted State Farm’s summary judgment
motion.
Camp’s sought coverage under Inland
Marine endorsements that provide coverage“for accidental and direct physical loss” tocomputer programs and electronic data. The
endorsements state that State Farm “mayelect to defend you” against suits arisingfrom such claims. The court ruled that theInland Marine endorsements did not cover
data breach claims brought by a third party.
The court explained that by referencing“direct physical loss,” the endorsements
unambiguously provide only first-party
coverage for losses sustained by Camp’s
itself. The court further held that the phrase“may elect to defend you” gives the insurer
discretion to defend but does not create a duty
to defend.
The court also ruled that coverage wasunavailable under the third-party coverage
provision for claims arising out of bodily
injury or property damage. The court
explained that the underlying claims allege
economic losses and not property damage.
Rejecting Camp’s contention that alleged loss
stemming from the issuance of replacement
credit or debit cards satisfies the property
damage requirement, the court explained:[E]ven if credit and debit cards are
tangible property . . . the Credit
Unions do not assert that Camp’s acts
or omissions caused physical harmor damage to any cards as tangible
property. Rather, the Credit Unions
assert that Camp’s lax computer
network security allowed the intangible
electronic data contained on the cards
to be compromised such that themagnetically encoded card numbers
could no longer be used, causing
purely economic loss . . . . (Emphasis
in original).

Coverage Alerts:
Delaware Court Rules That
Settlement Payments Are Not
Uninsurable Disgorgement

A Delaware trial court ruled that class action
settlement payments do not constituteuninsurable disgorgement under New York
law. TIAA-CREF Individual & Institutional
Svs., LLC v. Illinois Nat’l Ins. Co., 2016 WL
6534271 (Del. Superior Ct. Oct. 20, 2016).
TIAA-CREF was sued in three class action
suits that alleged failure to pay customers
gains that had accrued in their accounts.
TIAA-CREF settled the actions and sought
reimbursement of defense costs andsettlement payments from its liability
and excess insurers. The insurers denied
coverage and argued, among other things,
that the settlement payments are uninsurable
disgorgement under New York law. The court
disagreed and granted in part TIAA-CREF’s
summary judgment motion.
The court ruled that there is “no conclusive
link between the settlements in the
Underlying actions and wrongdoing by
TIAA-CREF that would render the settlementagreements uninsurable disgorgement.”
Although several New York decisions haveupheld coverage denials based on the public
policy against insuring disgorgement,
the court distinguished those rulings andstated that those cases “involve conclusive
links between the insured’s misconduct
and the payment of monies,” whereas here,

4

TIAA-CREF expressly denied any liability.
The court further noted that those cases
involved underlying actions brought by the
SEC or other governmental entities anddistinguished a settlement from “an orderto return funds.” See, e.g., J.P. Morgan
Securities Inc. v. Vigilant Ins. Co., 2013 WL
2475864 (N.Y. June 11, 2013) (discussed in
our June 2013 Alert).
The court also addressed several othercoverage issues. First, it ruled that St. Paul’s
policies cover the two class action suits thatwere filed after the expiration of its policy
period because the claims in those suits“related back” to a class action filed during
St. Paul’s policy period. Second, the court
held that coverage is not barred by thepolicies’ commingling exclusions because
the record did not indicate that TIAA-CREF
had mixed client accounts with its own funds
or had used client funds for its own private
benefit. Third, the court ruled that an issue
of fact exists as to whether TIAA-CREF
forfeited coverage by breaching a consent tosettlement provision. The court noted thatwhile coverage denials under certain policies
might affect the insurers’ right to enforce theconsent to settlement provisions, a questionof fact remains as to whether the insurers
retained the right to withhold consent withrespect to other policies. Finally, the court
concluded that the reasonableness of defense
costs presents issues of fact, rejecting theargument that the costs should be deemed
per se reasonable because of TIAA-CREF’s
incentive to minimize expenses based on theuncertainty about reimbursement.

Alabama Court Addresses Pollution
Exclusion And Timing Of Injury For
Sewage-Related Claims
An Alabama federal district court ruledthat an absolute pollution exclusion does
not bar coverage for claims arising out ofsewage exposure and that the date of injury
is determinative for purposes of policy period
analysis, not the date of the injury-causing“occurrence.” Evanston Ins. Co. v. J&J Cable
Construction, LLC, 2016 WL 5346079 (M.D.
Ala. Sept. 22, 2016).
The coverage dispute arose out of personal
injury and property damage claims causedby exposure to sewage. A sub-contractor
negligently struck sewer pipes during a
construction project, resulting in sewage

exposure in several neighboring homes.
Evanston denied coverage for the claims
based on an absolute pollution exclusion anda policy period defense. The court rejectedboth arguments.
The court ruled that sewage is not a pollutant
within the meaning of the exclusion, andthat the terms “discharge” and “dispersal”
in the exclusion have been interpreted torefer to traditional environmental pollution
under Alabama law. The court also dismissed
Evanston’s argument that all of the injuries
occurred after the policy’s November 12,
2013 expiration date. The court found thatwhile some evidence suggested that theunderlying claimants did not suffer injury
until November 16 or later, other evidence
indicated that plumbing problems had begunin the claimants’ homes earlier in time, whichraised a question of fact as to the timingof injury.

Defense Alerts:

Finding The Phrase “Arising Out
Of” Ambiguous, Massachusetts
Court Orders Insurer To Defend
Cosby Defamation Suit
Our November 2015 Alert reported on a
California decision holding that language
in a sexual misconduct policy exclusion is
ambiguous and that the insurer was therefore
obligated to defend defamation claims
related to sexual misconduct allegations.
AIG Prop. Cas. Co. v. William H. Cosby,
2015 WL 9700994 (C.D. Cal. Nov. 13, 2015).
This month, a Massachusetts federal district
court, faced with similar policy language andunderlying allegations, reached the sameconclusion. AIG Prop. Cas. Co. v. Green, 2016
WL 6637694 (D. Mass. Nov. 8, 2016).
5

The coverage dispute arose out of several
lawsuits against Bill Cosby alleging
defamation and intentional infliction ofemotional distress. The plaintiffs claimed
that in response to their allegations of assault
and rape, Cosby made numerous publicstatements that injured their reputations.
Cosby tendered defense of the action to AIG
under homeowners and excess policies. AIG
sought a declaration that it had no duty to
defend or indemnify the suits, arguing thatthe claims fell within a sexual misconductexclusion, which bars coverage for “personal
injury arising out of any actual, alleged,or threatened by any person . . . sexualmolestation, misconduct, or harassment.”
The court disagreed, denying AIG’s summary
judgment motion and granting Cosby’s
motion in part.
The court ruled that there was no conflict
between California and Massachusetts law
regarding interpretation of “arising out of”
in the sexual misconduct exclusion. The
court stated that under both states’ law, thephrase is ambiguous. The court explained thatwhile sexual misconduct is “no doubt related
to and setting the stage for the defamation
claims,” it is “multiple steps removed fromthe defamatory injury-causing statements.”
In deeming the exclusion ambiguous,
the court noted that a different policy
provision (applicable to “Limited Charitable
Board Directors and Trustees Liability”)
contained broader language excluding sexual
misconduct claims (“arising out of, or inany way involving, directly or indirectly, any
sexual misconduct”). The court declined torule on AIG’s indemnity obligations, notingthat the underlying claims have not yet been
resolved.

California Court Rejects Conflictof Interest And Untimely Defense
Arguments
A California federal district court ruled thatan insurer did not breach its duty to defend
and was not required to hire independent
counsel for the policyholder because no actual
conflict of interest existed. St. Paul Mercury
Ins. Co. v. McMillin Homes Construction,Inc., 2016 WL 5464533 (S.D. Cal. Sept. 29,2016).
McMillin, a general contractor, was anadditional insured under a St. Paul policy
issued to a landscape company. McMillan
tendered defense of a construction defect suit
to St. Paul, which it accepted subject to areservation of rights. After McMillin refusedto accept St. Paul’s appointed counsel, St. Paul
filed suit, seeking a declaration that it had theright to control the underlying defense andhad no obligation to pay counsel retained by
McMillin. McMillin counterclaimed alleging
that St. Paul breached its duty to defend
by failing to provide an immediate defense
upon tender and by ignoring a conflict ofinterest that warranted the appointment of
independent counsel. The court rejected thesecontentions and granted St. Paul’s summary
judgment motion.
The court disagreed that the nearly fivemonth delay between tender and St. Paul’s
acceptance of the defense constitutes abreach of St. Paul’s duty to provide a timely
defense, explaining that the time period
between tender and McMillan’s productionof documents to St. Paul (in response to St.
Paul’s claim investigation) is not considered
in determining whether St. Paul provided
a timely defense. The court explained that
insurers are entitled to a reasonable period
to investigate claims to determine coverage
issues. The record established that once
McMillin turned over the relevant documents,
St. Paul agreed to defend within five to sevenweeks. The court held that this delay wasreasonable as a matter of law. The court also
held that St. Paul was not obligated to appoint
independent counsel because McMillin failed
to demonstrate an actual, significant conflictof interest and mere “[a]llegations that theinsurer had theoretical incentives creating
adverse interests ‘do not cause a conflictrequiring independent counsel.’”6

Arbitration Alert:

Third Circuit Holds That Parties
Should Arbitrate Reinsurance
Dispute And That Panel Should
Determine Applicability of
Nebraska’s Anti-Arbitration Statute
The Third Circuit granted a motion tocompel arbitration, finding that an arbitrator
should address challenges to the arbitrationagreement and the applicability of a Nebraska
statute barring arbitration of insurance
disputes. South Jersey Sanitation Co.,
Inc. v. Applied Underwriters Captive Risk
Assurance Co., 840 F.3d 138 (3d Cir. 2016).
South Jersey, a garbage collection company,
entered into a Reinsurance Participation
Agreement (“RPA”) with Applied
Underwriters. The parties disputed the
purpose and effect of the contract; South
Jersey contended that the RPA provided
coverage for workers’ compensation claims
whereas Applied Underwriters argued
that it operated only as an investment
instrument. South Jersey sued Applied
Underwriters seeking rescission of the RPA
and alleging breach of contract, negligent
misrepresentation and fraud. Applied
Underwriters moved to compel arbitration
based on an arbitration provision in the
RPA. A New Jersey federal district court
denied the motion and ruled that under the
RPA’s choice-of-law clause, Nebraska law
governed the dispute and that a Nebraska
statute barring arbitration of insurance
disputes (Neb. Rev. Stat. Section 2602.01)
reverse preempts the Federal Arbitration Act
pursuant to the McCarran-Ferguson Act. The
Third Circuit reversed.
The Third Circuit explained that under
the Federal Arbitration Act, fraud-based
challenges to an arbitration provision may
be resolved by a court. However, “[i]f thechallenge encompasses the contract as awhole, the validity of that contract, like allother disputes arising under the contract, is amatter for the arbitrator to decide.” The court
concluded that South Jersey’s fraud claims
must be resolved in arbitration because they
contest the validity of the RPA as a whole,rather than only the arbitration provision.
The court also rejected the district court’s
reverse-preemption ruling. It reasoned that
it is unclear whether the RPA falls within
the scope of the Nebraska anti-arbitration

statute and that South Jersey’s contention
that the RPA “clearly relates to, concerns
and actually issues a workers’ compensation
policy” is insufficient to establish that the RPA
is “an agreement concerning or relating toan insurance policy,” as required by Section
2602.01. The court therefore concluded thatthe arbitration panel must decide whether
the RPA falls within the ambit of Section
2602.01 so as to give rise to a reverse
preemption issue.

Discovery Alert:

Tennessee Court Denies Motion
to Compel Information Relating
To Other Insurance Claims,
Claims-Handling and Reinsurance
Communications
A Tennessee federal district court denied
policyholders’ motion to compel the
production of information relating toother insurance claims, claims handing,underwriting, loss reserves and reinsurance
communications. First Horizon Nat’l Corp.
v. Houston Cas. Co., 2016 WL 5869580(W.D. Tenn. Oct. 5, 2016).
In this dispute arising out of alleged False
Claims Act violations, the policyholders
sought to compel their liability and excess
insurers to produce a broad range of7

documents. Denying all but one of the
motions, the court held:
Similar Claims Material: The court deemed
information relating to the insurers’
treatment of other claims to be irrelevant.
Rejecting the contentions that suchinformation bears on policy interpretationand the insurers’ alleged bad faith denial of
the claims, the court explained that even if theinsurers took conflicting positions in othercases regarding the same terms, it would
not aid the court in interpreting the policy
language at issue. Additionally, the court
concluded that requiring production of otherclaims material would be unduly burdensome.
Claims-Handling and Underwriting
Material: Policyholders argued that suchmaterials are relevant to the disputed
coverage issues pertaining to “interrelated
claims” or when an insurable claims accrues.
Rejecting this argument, the court explainedthat such information is irrelevant because
the excess policies at issue followed form
to underlying primary policies. Thus, even
if the excess policies were ambiguous, theunderwriting and claim-handling manuals
for those policies would be irrelevant.
Reinsurance Agreements andCommunications: The court granted
policyholders’ motion to compel the

production of reinsurance agreements,
ruling that Federal Rule of Civil Procedure26(a)(1) (which requires a party to produce“any insurance agreement”) encompasses
reinsurance agreements. However, thecourt denied the motion with respect toreinsurance-related communications.
Policyholders argued that such
communications are relevant because they
could “shed light on the Insurers’ intent”
and “could reveal whether the insurers
believed that these policies covered theclaims.” Rejecting this argument, the court
accepted the insurers’ contentions (and sworn
statements) that reinsurance communications
reflect the insurers’ business decision to
spread risk and not the substantive issues in
the coverage litigation.
Loss Reserves: The court noted that somecourts have deemed loss reserves relevantto the insurer’s valuation of the claim andalleged bad faith, while others have denied
production based on the “tenuous link
between reserves and the legal questionof coverage.” The court endorsed theview that reserves set by insurers are a“business judgment and do not reflect a legal
determination of the validity of the Plaintiffs’
claims against them.”

8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.

David J. Woll
+1-212-455-3136
dwoll@stblaw.com

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

Deborah L. Stein+1-310-407-7525
dstein@stblaw.com

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

Michael D. Kibler+1-310-407-7515
mkibler@stblaw.com

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

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

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

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

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

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

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

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

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

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

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.

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.
9SimpsonThacherWorldwide

UNITED STATESEUROPE

SOUTH AMERICANew York
425 Lexington Avenue
New York, NY 10017+1-212-455-2000

LondonCityPoint
One Ropemaker Street
London EC2Y 9HUEngland+44-(0)20-7275-6500

São Paulo
Av. Presidente Juscelino
Kubitschek, 1455
São Paulo, SP 04543-011
Brazil+55-11-3546-1000

Houston
600 Travis Street, Suite 5400
Houston, TX 77002+1-713-821-5650
Los Angeles
1999 Avenue of the Stars
Los Angeles, CA 90067+1-310-407-7500
Palo Alto
2475 Hanover Street
Palo Alto, CA 94304+1-650-251-5000
Washington, D.C.
900 G Street, NW
Washington, D.C. 20001+1-202-636-5500

ASIA

Beijing
3901 China World Tower
1 Jian Guo Men Wai Avenue
Beijing 100004
China+86-10-5965-2999
Hong Kong
ICBC Tower
3 Garden Road, Central
Hong Kong+852-2514-7600
Seoul
25th Floor, West Tower
Mirae Asset Center 1
26 Eulji-ro 5-gil, Jung-gu
Seoul 100-210
Korea+82-2-6030-3800
Tokyo
Ark Hills Sengokuyama Mori Tower
9-10, Roppongi 1-Chome
Minato-Ku, Tokyo 106-0032
Japan+81-3-5562-6200
10