The article of the month offers an analysis of the issues that may confront the makers and users of drones, along with possible insurance coverage for these issues. (Included in the article is a chart that highlights the differences and similarities between drones and hobby aircraft as well a commercial aircraft.)

See Drones.

Duty to Defend Article

The following article is written by Mr. Barry Zalma, Esq., CFE. Mr. Zalma is an insurance coverage attorney, consultant, and expert witness. He is a consulting editor of FC&S and has authored several books on property and liability claims.

Duty to Defend and the Bill Cosby Case

The comedian and actor, Bill Cosby, was accused by many women of acting dishonestly, immorally, and despicably. They have accused him of drugging them and then raping them, conduct that, if true, should never be covered by a policy of insurance. Cosby's homeowners insurer filed suit for declaratory relief, contending it has no obligation to defend or indemnify Cosby for intentionally sexually molesting plaintiffs, who claimed he defamed them when he denied their charges of rape and sexual molestation. As a result, Cosby has been required to defend four tort actions and two declaratory relief actions brought by his insurer, AIG, in two different states (because it wrote homeowners policies in two different states).

AIG in June 2015, sued Cosby in Massachusetts and California seeking declaratory relief claiming that the homeowners insurance policies it issued to him in those states specifically excluded the claims and suits filed by some of his accusers. It said these provide coverage for personal injury claims, which include defamation, but not for personal injury claims arising from “sexual, physical or mental abuse. The wording of the exclusion that AIG appears to rely on is under coverage E and states: “Coverages E and F do not apply to any to the following: 7. Sexual Molestation, Corporal Punishment Or Physical Or Mental Abuse.”

Reuters reported that Cosby—citing financial pressures—recently asked a federal judge to dismiss or put on hold a lawsuit in which American International Group Inc. sought to avoid paying for his defense against defamation claims by women who also accused him of sexual abuse. In a filing in the federal court in Springfield, Massachusetts, Cosby said he would face “substantial prejudice” by being forced to defend simultaneously against AIG over the policies and against the women over the defamation claims.

According to Reuters, Cosby's lawyers stated, “Forcing Mr. Cosby to fight a four front battle would demonstrate AIG's complete disregard for the best interests of Mr. Cosby. Not only does AIG's action bolster the underlying plaintiffs, who will perceive Mr. Cosby as under attack even from his supposed backers, but it splits Mr. Cosby's focus and drains his resources.”

There is no question that sexual molestation, especially sexual molestation of a child, is not subject to coverage under any liability policy, such as was decided in J. C. Penney Cas. Ins. Co. v. M. K., 52 Cal. 3d 1009 (1991). Cosby, though, has denied all of the allegations against him. Therefore, Cosby's argument, on balance, that the potential prejudice and hardship that could result from inconsistent factual determinations in the declaratory relief action and the tort actions brought against him should outweigh any slight amount of prejudice AIG may suffer from a temporary stay. Additionally, a temporary stay may result in the simplification of issues in this action, as happened in State National Ins. Co., Inc., v. US-SINO Investment, Inc., Case No. 5:13-cv-05240-EJD, 2015 WL 5590842 (N.D. Cal. Sept. 23, 2015) and Selective Ins. Co. of America v. Dail, No. 4:14–CV–00103–F, 2015 WL 5330109 (E.D.N.C. Sept. 11, 2015).

District courts possess significant discretion to dismiss or stay claims seeking declaratory relief, even though they have subject matter jurisdiction over such claims, as seen in R.R. Street & Co., Inc. v. Vulcan Materials Co., 569 F.3d 711 (7th Cir. 2009). If state and federal proceedings are parallel and the federal suit contains claims for both declaratory and nondeclaratory relief, the district court should determine whether the claims seeking nondeclaratory relief are independent of the declaratory claim. A claim for relief is independent of the declaratory claim if it has its own federal subject-matter-jurisdictional basis and its viability is not wholly dependent on the success of the declaratory claim. If the actions are parallel the court should avoid piecemeal litigation.

The court in Cincinnati Ins. Co. v. Silvestri Paving Co., No. 10 C 07971, 2011 WL 4686437 (N.D. Ill. Oct. 4, 2011), quoting Nationwide Ins. v. Zavalisi, 52 F.3 689 (7th Cir.1995), found that when the argument that the declaratory relief actions are premature because a determination as to coverage could require determinations of fact that could bind the parties in the underlying litigation, the court is not required to dismiss or stay where “the insurer's duty to defend…'can be evaluated without any excursion into fact-finding that would interfere with the…underlying state court suit.'”

However, Cosby's case is fact dependent. If the women prove he molested them sexually and then defamed them when he denied their allegations, the declaratory relief action will be unnecessary to prove the same thing. Similarly, if Cosby proves in the tort actions that he did not sexually molest the four women nor did he defame them, the declaratory relief action is unnecessary. The facts should, therefore, be determined once and should prevent AIG from forcing Cosby to litigate in multiple lawsuits to determine the essential facts, and staying the declaratory relief action will not prejudice AIG's rights.

As stated by the court in Mullen v. Glens Falls Ins. Co., 140 Cal. Rptr. 605 (1977), in most states, an insurer is required to go beyond the face of a complaint and instruct an adjuster to perform a thorough, independent investigation to determine if other facts exist that may give rise to a potential duty to indemnify. This means that even if the complaint alleges that the insured planned to abuse the women and then defamed them by denying their allegations, an insurer may not be able to refuse to defend its insured on the “intentional act” exclusion or the “sexual molestation” exclusion without first conducting a thorough investigation establishing the wrongful intent. The investigation could show that the allegations of the complaint are totally false and fraudulent. Perhaps Cosby was not even in the city at the time of the alleged molestation or was free of fault on another basis.

Note that the duty to defend is not limited to cases where the suit against the insured is viable. The duty extends to those that are brought against the insured that are groundless, false, or fraudulent.

Homeowners insurance policies insure against the risk of the cost to defend and indemnify an insured in case the insured is sued for a tort cause of action seeking damages from the insured. United States insurance law commonly concludes that the duty to defend promised by a liability insurance policy (like a homeowners policy) is always broader than the duty to indemnify. The broad duty to defend requires the insurer to defend its insured, even if the insured is dishonest, despicable, or immoral; if there is a potential that the allegations of the suit filed against the insured could possibly be covered, a defense must be provided.

The following case law fortifies that point.

In Wild v. Subscription Plus Inc., 299 F.3d 618 (7th Cir. 2002), the Seventh Circuit was faced with a dispute over the duty to defend when there was a finding that the insurer, Scottsdale, had no duty to indemnify the two insureds because the accident was not covered by the policy after all. Scottsdale appealed the judgment that it had a duty to defend. It also appealed from the court's correlative order, based on Oklahoma insurance law, that it reimburse the insureds for the expense of defending against the tort suit.

The Seventh Circuit, resolving the issue in favor of the insured, stated: “If the suit against the insured were meritorious, the insurance company would pick up the tab for defending, but if the suit had no merit the expense of defending it would be borne by the insured. That would make no sense. The insured who has bought a liability policy that entitles him to defense as well as indemnification wants to be defended against claims of liability regardless of their merit. He doesn't want to be stuck with the lawyer's bill just because he wins and therefore doesn't need to look to the insurer for indemnification. If he wanted that he would just buy indemnification and not defense.”

In Chipokas v. Travelers Indem. Co., 267 N.W. 2d 393 (Iowa 1978), the court held that a duty to defend any suit against the insured “seeking damages which are payable under the terms of this policy, even if any of the allegations of the suit are groundless, false or fraudulent … does not import a duty to defend where there is no claim within the liability coverage.”

In McGaughey v. St. Paul Fire and Marine Ins. Co., 744 P. 2d 598 (Or. Ct. App. 1987) the Oregon Court of Appeal construed a duty to defend provision to apply to suits “for covered claims, even if the suit is groundless or fraudulent” to mean that the insurer had no duty to defend a suit, even if groundless, unless the claim would be covered under the policy.

In Horace Mann Ins. Co. v. Barbara B., 4 Cal.4th 1076 (1993), the court found that under California law, an insurer has a duty to defend even if the claims against the insured are groundless, false, or fraudulent. Other jurisdictions have found the same, such as the court in U.S. Fid. & Guar. Co. v. Wilkin Insulation Co., 578 N.E. 2d 926 (Ill. 1991). The Illinois court also said, “Moreover, if the underlying complaints allege several theories of recovery against the insured, the duty to defend arises even if only one such theory is within the potential coverage of the policy.” In Montrose Chem. Corp. v. Superior Court, 6 Cal.4th 287 (1993), the court said, “Any doubt as to whether the facts establish the existence of the defense duty must be resolved in the insured's favor.”

The court in Cincinnati Ins. Co. v. Eastern Atlantic Ins. Co., 260 F.3d 742 (7th Cir. 2001) stated, “What is important is not the legal label that the plaintiff attaches to the defendant's (that is, the insured's) conduct, but whether that conduct as alleged in the complaint is at least arguably within one or more of the categories of wrongdoing that the policy covers.” The court went on to say that “the duty to defend is not limited to meritorious actions; it even extends to actions that are groundless, false, or fraudulent as long as there exists the possibility that the allegations implicate coverage.”

In Lexington Ins. Co. v. Charter Oak Fire Ins. Co., 81 A.3d 903 (Pa.Super.2013), the court declared, “The duty to defend persists until an insurer can limit the claims such that coverage is impossible.”

No one knows how the court will rule, but it appears the equities favor Cosby, who faces multiple accusations he claims are false. As a result, he has been sued and is entitled to a defense from his insurers until there exists proof that the exclusions apply. A decision on coverage should never be established by an allegation emphatically denied by an insured. Rather, there must be a finding from a preponderance of evidence that the exclusion applies.

All Risk Policies and Ensuing Loss Claims

The insured beverage bottler brought an action against the property insurer to recover for the destruction of almost 2 million bottles due to failure to pass quality control tests for sealing. This case is H.P. Hood v. Allianz Global Risks U.S. Insurance Company, 2015 WL 6629484.

Hood suffered various losses when a bottled beverage it was producing for another company failed certain quality control measures. Hood was producing bottles for Abbott Laboratories, but the quality test runs showed that the bottles did not sustain hermetic seals after the pressure inside the bottles was increased due to faulty liners in the caps. After Hood reported its preliminary test results to Abbott, Abbott said it would not accept the bottles. Hood and Abbott agreed that the bottles were to be destroyed.

Hood sought coverage for the lost bottles from its insurer, Allianz. The insurer denied coverage, saying that actual property damage must occur before coverage is triggered and there was no evidence that any bottle sustained physical damage before Hood decided to destroy the entire run of bottles. The insurer argued that, as a matter of law, a mere increased risk of future property damage is not itself covered by the policy. When Hood sued for coverage, the trial court entered summary judgment for the insurer. This appeal followed.

The Appeals Court of Massachusetts, Suffolk, after examining the policy language, noted that any losses at issue here fell within an exclusion. The policy included an express exclusion for faulty workmanship, material, construction or design from any cause. The court said that the plain language of the exclusion applies to the bottle cap liner issue with the bottles, and moreover, when a company assumes the obligation of completing its work in accordance with plans and specifications and then fails to perform properly, it cannot recover under the all risk policy for the cost of making odd its faulty work.

Hood argued that even if the defective workmanship exclusion applied, it would apply only to a limited extent. Hood said the exclusion at most precludes coverage only for the bottle caps themselves and that other losses, such as the loss of the product inside the bottles, are covered. The court listed this argument as an ensuing loss argument and saw the argument of the insured as a dispute with the insurer over what boundary the policy intended to draw between those property losses caused by faulty workmanship that are excluded from coverage, and those ensuing losses that are not.

The court ruled that on the particular facts of this case, Hood cannot prevail under any reasonable interpretation of the ensuing loss language. The court noted that damage that falls under the exclusion and the ensuing damage that is covered must be separable events in that the damage and the ensuing loss must be different in kind, not just degree. In this instance, the court continued, to the extent that Hood suffered property damage potentially subject to coverage, that loss was directly caused by, and completely bound up in, the increased risk of future spoilage. Both conceptually and practically, the losses entailed here cannot reasonably be characterized as separable.

The court ruled that the loss here fell squarely within the exclusionary language and the ruling of the trial court was affirmed.

Editor's Note: The Appeals Court of Massachusetts rules that the defective workmanship exclusion under an all risk policy barred coverage for the insured's property loss. Moreover, the ensuing loss exception did not prevail because damage that falls under the exclusion and ensuing damage must be separable events, and that was not the reality in this instance.