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Most large U.S. companies buy catastrophic liability insurance through a Bermuda Form, a unique policy with many features designed to protect the selling insurance company. Further, Bermuda Forms require arbitration in London or Bermuda, under English procedural law and modified New York substantive law. John Ellison, Richard Lewis and Catherine Lewis explore how best to incorporate the Bermuda Form into policy programs, as well as the unusual hurdles to recovering under the Bermuda Form.
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Intro: Hello, and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues, and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
John: Hi, everybody, and welcome back to Insured Success. our continuing podcast series of important insurance topics. And today's topic is the Bermuda Form Part 1. This will be part of a two-part series we're going to do on this unique insurance product. And today's focus will be on the history behind the Bermuda Form and its development, and then some of the key policy terms. And then in our next episode, which will be coming out shortly, we will discuss how to perfect coverage under the Bermuda Form and issues relating to the unique dispute resolution provisions that are in the form. Today, our presenters are going to be my colleagues, Rich Lewis, who's a partner in the New York office, and Catherine Lewis, who is a senior associate in our London office, and I am John Ellison, a partner in the Philadelphia office. The three of us work together often on these Bermuda Form matters, as do many members, other members of our group. And due to our firm's geographic setup, depicted today by Catherine in London and Rich in New York, you'll learn that our firm is uniquely qualified and situated to handle these types of issues. So, Rich, I'm going to turn it over to you to give us some of the history and overview of the Bermuda Form. Rich.
Richard: Okay. Well, I don't know, obviously, our listeners' experience with coverage disputes, but policyholders in the 70s and 80s started buying a lot of liability insurance, and that had to do with developments in tort law in the United States. And if you've ever been involved in a case involving those policies, they typically were occurrence forms triggered by injury or damage in the policy period. And the coverage charts, as you got later in the 70s and through the 1980s looked like ski jumps. Companies were buying hundreds of millions of dollars of insurance in the late 70s and the early 80s. This also, as I'm old enough to remember, accelerated a lot in the early 80s because of the high interest rates that insurance companies could get. It was something called cash flow underwriting, where they would underwrite lots and lots of policies just to get the premiums in to invest the income. The bill came due in the mid-80s for a couple of reasons. One, there were a number of coverage decisions in the asbestos context that said that multiple policies could be triggered by the same injury to one person. So that meant that in an asbestos case, many, many years of coverage from the early 60s through the time when asbestos exclusions were more common in the early 80s could be triggered. The second reason was circled liabilities from environmental cases. And as a result, everybody was recovering under these policies that had been sold for not very much premium so that the carriers could get the money in the door. And what happened was the liability insurance market crashed. You literally could not buy liability insurance from any of the major players in 1985. So what happened was a number of Fortune 50 companies got together with Marsh & McLennan and they created a Bermuda form company called ACE. And that started in 1985 and it would, it, it, provided liability insurance above $100 million. So true catastrophe liability coverage. And as Catherine will discuss, the core development of the Bermuda form as introduced and rolled out with ACE in 1985, and then another company, XL in 1986, was that it confined coverage to one year. So carriers weren't being held liable for years and years of coverage when they sold decades of coverage to somebody. The second part of the Bermuda form, which we will also talk about, is it allowed policyholders triggering that one year to spike their coverage all the way up a Bermuda form tower. And now I'm turning it back to Catherine.
Catherine: So as Rich said, the North American market policies were often written on an occurrence basis, and the Bermuda form is a departure from this. So for occurrence-based policies, their coverage is triggered on the occurrence of some event, for instance, when the bodily injury was suffered or the property damage occurred. And the other type of policy we're all familiar with is a claims-made policy. And this is one where the policy response is linked to the time at which the claim is first made by the underlying plaintiff. And it is the time of the claim made against the policyholder and not the time at which the underlying injury or damage occurs that triggers the policy response. And subsequent acts or omissions by the policyholder might affect the cover available, but the link of the policy to the underlying injury or damage is the time at which the claim is made. The Bermuda form is what's called an occurrence first reported form. And as the name suggests, it's a hybrid of the two. For an occurrence first reported form, it's the report of the occurrence to the insurers that triggers cover and the crucial report or notice is the first notice of such occurrence and the wording of the policy which we will come on to is such that notice is a mandatory condition to cover.
Richard: Which leads us into our next topic, which has always been a funny one for me, that when the forms were first rolled out in 85 and 86, as we will talk about later, and they're still controlled by New York law, but they also have a provision that says that the only thing you can look at is the policy language. You can't look at it in extrinsic evidence if something is ambiguous. The problem that the Bermuda Form Company soon discovered in ’85 and ’86 was that New York law was a, with regard to notice was a no prejudice state, meaning a carrier did not need to show that they were prejudiced by late notice to escape payment. And so policyholders recognizing New York law controlled ended up flooding Bermuda form companies with notice of every little claim because they didn't want to get poured out. So what ACE and XL did is they generated these things called notice guidelines that said essentially only give us notice of events that are likely to impact our layer, which I've always been amazed at the cheek of the insurance company, the Bermuda form companies to do that. Because if there is one body of people who are unlikely to look at something extrinsic to the policy, especially when the Bermuda form forbids you from looking at extrinsic evidence, it's the English barristers who are going to be on your panel. But anyway, it's now accepted that New York law has since changed. It's now accepted that you You only need to give timely notice of events that are likely to impact the policy. The next issue we're gonna talk about is batching and integration. Batching and integration, as I hinted before, is it's the flip side of the fact that only one policy period is triggered by a notice of an occurrence. What you can do under a Bermuda form policy is you can give notice of an integrated occurrence by designating a bunch of injuries as being related to an integrated occurrence or being related to each other. What that does is it pulls all of the injuries, regardless of the year in which they occurred, and regardless of the fact that you may have given notice in a previous annual period of an injury from a related occurrence as a separate occurrence. It pulls all of the injuries into the year in which you give notice of an integrated occurrence. There are some questions that will arise that we'll talk about in part two as to what happens if some of the injuries in your integrated occurrence happen before you bought the policy or what you do with regard to injuries that continue to occur after you give notice of an integrated occurrence. We'll talk about some of the devices that address that latter issue later. But what you need to know about an integrated occurrence is it's different from the ordinary common law concept of one occurrence and how you determine whether there's one occurrence or multiple occurrences. New York law on that is terrible. It doesn't bunch related injuries into one occurrence necessarily. And, Also, it's important under the Bermuda form that injuries that occur more than 30 days apart are deemed to have been caused by separate occurrences. So you have to be very aware of whether injuries that are caused by a common event or a common drug, whether you're going to aggregate them when you give notice of them.
John: So now let's come on to some of the specifics of the Bermuda form and kind of the basic coverage grant and coverage provisions. Provisions as Rich and Catherine were explaining this policy form has largely become a substitute for the what we call the historic occurrence forms and so in in that sense it it largely covers the same types of claims that a policyholder may face which are ones that allege either personal injuries or property damage or some type of advertising liability but within that broad scope, there are some unique concepts that differentiate the Bermuda Form from the old occurrence forms. And Catherine, let me pass it to you to start to walk through some of those.
Catherine: All right. So the Bermuda Form is, at its basic level, an insurance against legal liability. This is set out in the coverage clause. A policyholder must prove an ultimate net loss. This is obviously most easily satisfied by amounts that the policyholder has actually paid. There must be a legal liability to pay the ultimate net loss. That legal liability term is not defined and is therefore a matter for the governing law. It must also be in respect of damages, which is a defined term. Those damages must be on account of personal injury, property damage or advertising liability, as John said. The definition of damages is restricted to those which the policyholder is obligated to pay by reason of judgment or settlement for liability. As you can imagine, this is potentially challenging for policyholders where there is a commercial settlement and no liability. The final limb of the coverage clause is that the liability is encompassed by an occurrence, which we will come on to in a bit more detail shortly. But I guess the key takeaway from this sort of coverage clause is that the key to two, unlocking cover is actual liability. How that liability is established is a matter of New York law, which we can come on to and will depend, of course, on the particular facts at issue.
John: And we will dive into this a little more deeply in phase two of our Bermuda Form podcast. But one of the big differences between New York law and English law, for example, is what needs to be demonstrated by the policyholder to establish legal liability that would be covered by the policy. And fortunately for policyholders that buy the Bermuda Form, New York law does not require actual liability to be established in order to trigger the coverage. but we'll dive into that a lot more deeply in the next go-round. But Catherine, why don't you take us back then into some of the details of occurrence and how that works under the policy?
Catherine: Sure. Thanks, John. So we discussed already at a high level that the Bermuda Form is an occurrence first reported form, and the occurrence definition is therefore pretty important. It's also fair to say that it's a pretty complex definition, and it's performing a number of functions. And certainly in our experience, as a consequence of that, it can lead to certain coverage debates. But just taking a step back, the definition of occurrence seeks to achieve a number of things. It fixes the temporal limit of cover. And by that, I mean whether the policy responds to historic issues and how far it's forward looking. The definition also contains aggregation language and the extent to which claims can form a single loss. The definition defines the types of losses or the ensured perils. And finally, it deals with issues of intentional harm and fortuity. And I think Richard's going to come on to that in a moment. And so part of the complexity also stems from the broad type of harm that the policy is intended to respond to. And that includes where the actual harm has occurred or where it's only alleged. The policy can also respond to cases where there is injury of a prolonged period of time or where there's a single catastrophic event. And there will also be cases where liability is alleged but never proven and where the underlying facts might be disputed. So a fairly complex structure in that sense and the definition is rather than assessed in two limbs. The first limb applies to anything other than product liability claims and the second part applies only to product liability claims. Taking the first limb there must be an event or continuous intermittent or repeated exposure to conditions which event or conditions commence on or subsequent to the inception date and before the termination date which cause actual or alleged personal injury, property damage or advertising liability. And the second limb responds to actual or alleged personal injury to any individual person or actual or alleged property damage to any specific property arising from the insured's products that takes place on or subsequent to the inception date and before the termination date. Both limbs therefore require an actual or alleged personal injury, ] each as defined in the policy and for the product liability claims so limb two that injury or damage must simply arise from the products and there is no further qualification about how that injury should arise. The first limb which is anything other than product liability claims is on its face at least more specific as to how the injury damage or liability is said to occur as it seemingly requires a more concrete causal link to the event that said there is a reference obviously to alleged which suggests that the first limb does capture alleged injuries suffered even when none on the facts were so suffered. We discussed at the start of the podcast the difference between claims made occurrence-based and occurrence-first reported policy forms and it is in this definition of occurrence that distinction becomes very clear between the types of policy forms. It is in the definition that the timing of the occurrence is relevant and we can discuss in more detail the timing of when a claim is made when we discuss notice provisions later on and again in part two.
John: Yeah, and just to add one brief comment, Catherine, to your remarks, this is definitely one of the tricky areas of the Bermuda Form and it really is important when it comes to the point at which you're making a claim because often there are challenges from insurance companies about the scope of the occurrence or what falls within an occurrence that is noticed by a policy holder. So framing the occurrence and tying it to the specifics of the insuring agreement that Catherine just walked through is really critical. But we will, as Catherine said, we'll come back to that in a lot more detail in part two of this podcast. But now to make things even more complicated, Catherine, why don't we segue here into the integrated occurrence concept where we talk about how, you know, how we pull what would normally be considered a bunch of separate occurrences potentially under New York law into one giant integrated occurrence. How does that work?
Catherine: Thanks, John. And you're right, it just takes the complexity to another level, perhaps. And Rich touched on this earlier. But treating multiple losses as a single occurrence is a key feature of the Bermuda Form policy. The integrated occurrence language is not interchangeable with traditional aggregation language, but it is related. And parties to complex insurance programs generally will be well aware of the coverage disputes that can arise about the extent to which underlying claims are to be treated as a single claim for the purposes of the policy response and accessing limits of liability. So an occurrence under a Bermuda Form policy can be included in an integrated occurrence where there is an occurrence which we've discussed encompassing personal injury, property damage or advertising liability to two or more persons or properties commencing over, first, a period longer than 30 consecutive days, and second, attributable to the same event, condition, cause, defect, hazard, and or failure to warn of such. Quite a mouthful. To take full advantage of the integrated occurrence wording, the noter should be specific that the occurrence is an integrated occurrence. So if the aggregation is permitted under the language, then one looks to the aggregating language in the cause. This is very broadly drafted and requires only that the injury or damage is attributable directly, indirectly, or allegedly to the same actual or alleged event, condition, cause, defect, etc. So the question isn't what the injury or damage is, but what caused the injury or damage. And this broad aggregation language can enable a policyholder to aggregate a wide number of claims to take advantage of the full limits of liability and pay only a single deductible. And a fundamental issue that we see arising out of integration occurrences under the reform is whether the cause or defect is the same.
John: And again, just to reiterate, because this cannot be overstated or said often enough, These terms, occurrence and integrated occurrence, are critical to understand when presenting your claim to the insurance company so that the description of it is framed properly and as broadly as possible to encompass as much of the risk and the loss that the policyholder is facing. Fall within the scope of the claim that is being presented. Again, we're going to come back to this a lot in phase two of the podcast. But Rich, why don't we turn to some other issues that arise under the form that have some unique aspects, especially under New York law?
Richard: Well, the Bermuda Form states flatly that any injury, actual or alleged injury that is expected or intended will not be part of an occurrence. And this is a common issue that has arisen in New York law for decades. And New York law couldn't be better if I'd written it myself. Essentially, there's an old learned hand case where he said, you can drive around New York running every red light and know that eventually you will get in a crash, but the specific crash you get in won't be expected by you. And that's essentially the standard in New York. You have to to specifically intend, the policyholder has to specifically intend to intend the injury to the specific person to which the injury is actually or allegedly occurs. Whose knowledge is it? Well, ordinarily under New York law, it would be a member of the control group. One thing that has arisen in a couple of our Bermuda Form cases recently is that in the later versions of these Bermuda Forms, and we're on version four for XL and version five for ACE, the carriers changed expectation or intent of the insured to expectation or intent of an insured. And that can be an issue. We had a case a while ago in which that involved unnecessary surgeries. And the issue is whether the hospital expected or intended the injuries to the patients. But, you know, The carrier argued, well, obviously the surgeons did, and the surgeons are uninsured. And we had to litigate the issue of whether the surgeons were essentially on a frolic and detour or their actions were not attributable to the insured being the hospital. Yeah. The question of whether it's a subjective or an objective intent, this comes up almost in every case. Obviously, the policyholder will say, well, it can't be objective because an objective intent is just negligence and liability policies are supposed to cover negligence, so it has to be subjectively intended by the insured. Then the issue arises sometimes of the timing of the determination and the policyholder will say, well, the timing of the determination has to be the first day that I bought Bermuda Form coverage because technically Bermuda Form policies are a single policy that's renewed from annual period to annual period. What the carriers will say is that it's a rolling inquiry, especially like in a drug case where you continue to sell a drug and it continues to, you know, there are minor levels of injury, and then there's a great deal of injury. Carriers will say at some point on this rolling inquiry, you expected or intended injury from the drug if you continue to sell it. Another issue is what's called a maintenance deductible. That is a mechanism in the Bermuda Form that recognizes that a policyholder that sells drugs or sells toasters will inevitably. Have injuries every year from that product if they sell a bunch of them. And so what the maintenance deductible says is, you know, the ordinary level of injuries caused by your product, won't cause an eventual spike in injuries in a particular year to be deemed to be expected or intended, just that the policyholder will have to eat a maintenance deductible of essentially the noise level of claims. The final issue is what have been in since I think the third ACE version, which is a commercial risk exclusion, or actually XL4 and ACE5, I think. And the commercial risk exclusion deems injuries from a product to be expected or intended if those products are released into the market after notice of an integrated occurrence. It does accept injuries that are vastly greater, vastly different or that are different or vastly greater in magnitude by order of magnitude. And ordinarily the carriers say that means 10 times as big. Back to Catherine for some exclusionals.
Catherine: I’m going to talk briefly about the known occurrence exclusion. And this goes to the issues of fortuity and the fact that the issue must be unexpected and unintentional. So there's no express exclusion in the standard form that mentions fortuity or known loss or known risk and one argument for the rationale for that is that those purchasing insurance and this type of insurance in particular do so because they expect an element of risk or loss and provided that remains uncertainty as to the type and level of loss it will not offend the fortuity principle. As always and as Rich said earlier the timing of the increasing claims or or awareness of the potential claims and the potential loss, is an area that we see being challenged by insurers. All that said, there is a known occurrence exclusion endorsement which provides as a condition precedent that a policyholder was not aware of such occurrence prior to the date specified within the endorsement. And very similar to other discovery type provisions, this then requires an analysis of the knowledge of the relevant directors, officers or managers in risk management, insurance or legal departments and to establish who was aware of an occurrence and when. This type of wording or exclusion is not a particularly unusual concept and is intended to ensure that notices are made to the proper year and that policyholders with this wording we would always remind them of the importance of making any notifications prior to renewal. And I think Rich is going to pick up on some of the other exclusions in the policy.
Richard: I’m going to talk about two other types of exclusions that will preview a little bit of the second podcast. The first is what is labeled the securities, antitrust, etc. Exclusion, which seems pretty harmless, but it has a free-floating term in there of fraud. And I've seen it pled in almost every Bermuda Form case I've been involved that some part of the injury is due to fraud because almost every complaint, tort complaint, will allege fraud. This is not usually a terrible issue for reasons we'll get to in the second broadcast, but essentially under New York law, there can be an allocation of what you settle or an allocation of any judgment and very little of what policyholders end up paying even in a complaint that alleges fraud is due to fraud. The second issue is what I'll call laser exclusions. And you'll see these exclusions appended to the policy form as, again, it is just renewed from annual period to annual period. And what will happen is the Bermuda Form carriers will see a number of their policyholders making claims for a particular type of thing, whether it be asbestos, silica, or MTBE back in the day, and they will add a laser exclusion for the renewal. Which just means that your insurance department has to be on its toes. And when you are renewing and a laser exclusion is being added, you're going to have to give notice of an integrated occurrence under the expiring policy form if you have those types of exposures.
Catherine: Great. Thanks, Rich. We're going to talk a little bit now about the law of construction, which we discussed briefly earlier, and regarding the interpretation of the Bermuda Form. And this is where things get quite interesting for practitioners and potentially quite complicated for policyholders. The form is unique in terms of the applicable law. It is to be construed in accordance with New York law. However, the general principles of New York law are modified. So for instance the recovery of punitive damages may be prohibited. The biggest challenge however is the modification insofar as the construction and interpretation of the policy is concerned. The policy does not introduce a different system of law for construction for instance English law but seeks to modify the principles of New York law. I'll hand over to John and Rich very shortly as there will be very few people on the planet who know more about this than them but I wanted to highlight a few points to note. So firstly, the policy is to be construed in an even-handed fashion, and that includes in cases of ambiguity, and so therefore it disapplies the principle of contra proferentum. And there's also to be no reference to the reasonable expectations of either party, any reference to parole or other extrinsic evidence when it comes to interpretation. And finally, to the extent that New York law is rendered inapplicable by virtue of the points I I just mentioned, then English law applies.
Richard: Yeah the one thing I will raise on this, and maybe John wants to talk to it too, is that this can be a huge thing. John and I had a case involving an unusual exposure that the carrier said was barred by a pollution exclusion, and it didn't involve traditional environmental exclusion. And John and I had collected all these cases, and the case law couldn't have been better for us that unusual exposures that aren't traditional pollution are not barred by a pollution exclusion. And on the first day of the hearing, the panel said, well, yeah, those are all right out because they all mention ambiguity as a backup reason. And so it can be a hugely impactful thing, the manner of the construction provision and the Bermuda Form policy.
John: What I will say is that that is not the right conclusion that should be drawn on how New York law should be applied and interpreted in these arbitrations, that is an argument the insurers are likely to raise. But I think it's fair to say that other panels have not gone the way as the one that Rich just mentioned. And just because a New York case happens to mention ambiguity doesn't mean it should be thrown out the window for all purposes. But we're going to come back to this a lot in phase two. So let's leave that there for the moment. But what I think this does amount to, especially for a U.S. Company, is that you really need to look at these claims and any disputes that arise about the claims in a different manner because the arbitration becomes much more of an English law exercise in some respects because you're not able to introduce things that you routinely introduce in a U.S. Litigation like parole evidence or other types of information that might inform the court's interpretation of the policy, you really need to take the policy as it's written and argue from that as you would in an English court. And that's where the barristers come in, you know, and we often work closely with them in crafting our arguments because coming at it from a U.S. perspective is helpful, but it then needs to be translated, so to speak, using air quotes around translated, into the English version of what New York law is. And that really requires cross-ocean effort to get the message presented in the best way possible. And as I just mentioned, the dispute resolution procedure here is arbitration before three arbitrators, typically in London, but sometimes in Bermuda or Toronto. And we're going to get into a lot more detail on that in the Bermuda Form Part 2, which will be coming out shortly. But we thank you all for listening to us today. Any of us are available to answer any questions by email or otherwise. And we hope you join us again for the next Insured Success Podcast, Bermuda Form Part 2. Thanks very much.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's insurance recovery group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
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With hurricane season underway and wildfires ravaging parts of California, understanding how to go about an insurance claim after a natural disaster is as important as ever. In part one of a two-part series on the topic, Matt Weaver, Chris Kuleba and Jessica Gopiao take listeners through many of the issues commonly faced by property owners immediately following a loss or potential loss and offer important advice for anyone in such a situation.
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Intro: Hello, and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues, and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Matt: All right, welcome back, everyone, to the Insured Success Podcast. My name's Matt Weaver. I'm a partner here at Reed Smith in the insurance recovery practice in Miami. I'm joined here by two of my favorite people, my partner, Chris Kuleba, who also sits with me in the Miami office, and my colleague, Jessica Gopiao, who splits her time between California and South Florida. It's hurricane season. It's also, unfortunately, wildfire season. We're here to talk today about some practical things and some important pieces of advice for anyone who's facing a loss or a potential loss due to any one of these events. Jess, Chris, you want to say anything more about who you are?
Chris: Sure, Matt. Thanks, and thank you for everybody for tuning in. My name is Chris Kuleba. As Matt mentioned, I'm a partner at Reed Smith in our insurance recovery group. I'm based in Miami. I've been doing insurance recovery work essentially my entire career. I was barred in 2013, so I'm going on 11 years now. I'll turn it over to Jess.
Jessica: Hello, everyone. My name is Jessica Gopiao. I am a senior associate and member of the Reed Smith's Insurance Recovery Group. As Matt had mentioned, I split time between South Florida and Southern California. Back in June, I chatted with Rich Lewis and John Ellison about navigating insurance claims after natural disasters. And with hurricane season being amongst us and the record-breaking wildfire season, we are now going to talk more about that.
Matt: So I think the goal here for everyone is to focus on what we, in our experience, have seen as key issues in these cases and these claims that drive outcomes. A lot of things can happen in the course of an insurance claim. Some of it is important. Some of it, candidly, is not. But we want to talk a little bit about things from our perspective that tend to really matter and tend to push these claims in one direction or the other. So Chris, you want to start us off?
Chris: Sure. And as Matt mentioned, this is by no means an exhaustive list. What we'd like to do is sort of take you through some of the sort of big picture, significant driver issues, starting from the beginning of a loss through the claims process and then through a process that's called appraisal, which is a alternative dispute resolution process found in most property insurance policies, though the nature and the scope of those provisions can vary based on the text of the policy. But first, if it's okay with everybody, I'd like to start with some causation issues. And by that, I mean when an insured or a property, I should say, suffers a loss, what is the relevant cause of that loss for purposes of determining coverage? In the instance of a hurricane or a wildfire, that is often very obvious, at least with respect to some of the immediate damage. But you'll find, as many of us have, that when submitting a claim, an insurance company will often point to damage, maybe that preexisted a hurricane or preexisted a fire in the case of a partial loss and seek to find ways within the policy to deny coverage for all or part of a loss. And one of the key drivers in terms of coverage when it comes to causation is what state or what causation doctrine, I should say, is applied in the particular state. In Florida, we follow something called the concurrent cause doctrine, which is one of two predominant causation doctrines in states throughout the United States. The other, which is particularly relevant for wildfires, since this is a California doctrine, the efficient proximate cause doctrine. Generally speaking, the concurrent cause doctrine at bottom says when there are two or more causes of loss, one of which is covered and one of which is not. That combine to cause a loss, the loss is covered absent some specific policy language called anti-concurrent cause language that we'll talk about in a minute. And the reason that's important is going back to that example of pre-existing damage. If you have, say, a hurricane that damages part of the house, an insurance adjuster comes out and says, well, some of this looks like it existed prior to the hurricane. We see some of this is new, but we're only going to pay for the part that we see is brand new and not things that were made worse by the hurricane. An example could be leaking windows. You had windows that maybe weren't built correctly or they're older and they had very minor leaks prior to a hurricane. And a hurricane comes, the windows are suddenly leaking large amounts of water. They're no longer sealed. And if in that situation, an insurance company may point to either a faulty workmanship, construction defect type exclusion. It might point to a wear and tear exclusion, it might point to a pre-existing damage exclusion. But under the concurrent cause doctrine, because the hurricane, being a covered cause of loss, exacerbated that existing damage, the loss should be covered. Under the efficient proximate cause doctrine, in contrast, you look to the predominant cause of the loss, the one that puts the sets the others in motion. And that doesn't have to be the first cause and it doesn't have to be the last cause in the causal chain. It just has to be the predominant cause. For example, if you have a say you have an old house that settled naturally over time and was then coated with ash from a wildfire and an insurance company will come out and say, well, the cause of the ash, the predominant cause of the ash is certainly the fire. But what if the ash from that fire clogged the property's drains and a rainstorm, say, came in, and because the rain could not drain through those drains, it backed up into the house and around the house and caused water damage in the house? In that instance, what would the efficient approximate cause be? Would it be the rain or would it be the fire? Now, this may not be the best example because typically both of those causes, both rain and both fire, are going to be covered. But let's say in this particular policy, rain is excluded, but loss caused by fire is covered. The insured would argue, and in my opinion, they would be right, that the efficient proximate cause of that water damage is actually the fire. Because without the fire and the after clogged drains, the water would not have backed up into and around the house, causing that water damage. So the predominant cause in that instance would be the fire. Now, before I continue, I'll take this over to Matt or Jess, if there's anything you want to add so far.
Matt: So maybe, Jess, you can talk a little bit about why this issue is important and why, from the policyholder's perspective, this can really make a difference, depending on what standard applies and depending on the causes you're dealing with in a particular loss.
Jessica: So the reason why I think we had started this episode talking about causation is because we are focusing on wildfires and hurricanes. And the first question when presented with a coverage issue under a policy is, what caused the damage? And what Chris is talking about is answering the question of, did the hurricane cause the loss? Or in his hypothetical, did the fire cause the loss? So when presented with certain damage to property, the first question is, what actually caused it?
Matt: Chris, I mean, in your experience, I think there's an issue here that's important about burden of proof and scope of loss that tends to show itself later down the line. Do you want to talk a little bit about that?
Chris: Sure. And I'm glad you brought that up because burdened proof is a really important topic. So speaking in very broad terms here, there's two different types of property policies. And it doesn't matter if it's residential or commercial. The two types of policies I'm referring to are one, what's called an all risk policy. The other is a enumerated or specified peril policy. And an all risk policy, all causes of loss are covered, except if they're specifically excluded in the policy. So in that in that type of policy, the scope of covered causes of loss is defined not necessarily by the coverage grant, but by the exclusions themselves, because everything is covered unless it's not. In a enumerated or specified perils policy. It's a bit different because there's only certain perils and those are set forth in the policy that are actually covered. So if a loss was caused by peril, I mean a cause of loss, and using the examples we've been using, a hurricane is a peril, a fire is a peril. So unless the loss was caused by one of those perils set forth in the policy, it's not going to be covered. And this is an important distinction, one, because all risk policy provide very broad coverage. They're more policyholder friendly. And it also has an impact on the, quote, burden of proof in terms of who bears the burden of proving what the cause of loss is. Under an all-risk policy, as long as the insured can show that there is property damage during the policy period, the burden should then immediately shift to the insurance company to prove that the loss is excluded. And the reason for that is, as I mentioned, all causes of loss are covered unless they are specifically excluded. And the insurance company, as a writer of the insurance policy in most instances, is going to have the burden to prove that an exclusion applies to the entirety of a loss. Under a specified or enumerated peril policy, the policyholder, the insured, is going to have to prove that one of the enumerated perils caused the loss. And when it comes to litigation and when it comes to supporting a claim, that burden of proof can be very, very important.
Matt: Yeah. And to kind of bring this back a little bit big picture, when we talk about burdens of proof and we talk about what's covered and what's excluded and framing it and what's going to drive your success on your claim, the less burden the insured has, the easier it will be to prove. And that sounds a little bit obvious, but that's why these rules are so important. If the insurance carrier has a higher burden, in other words, under a concurrent cause situation. Let's say there's covered hurricane damage or covered wildfire damage for that matter, and you've got a building that also has construction defects, it's not going to be enough for the insurance company to come along and say, oh, well, guess what? The construction defects, which are excluded, contributed to your damage. Therefore, we have no coverage obligations. Under the concurrent cause doctrine, if you've got that covered peril and that covered peril contributes to your damage, the entire loss is covered, regardless of the presence of an excluded peril. So when you're talking about ease of proof and ease of burden, it's very, very important at the outset to try to understand, one, what are the different causes of your loss? And two, which one of these rules is going to apply?
Jessica: And to kind of loop it back to the all-risk versus named peril distinction, if it is an all-risk policy, one argument that we like to put forward is that if it is all-risk, then as Chris had mentioned, if there was just damage that had happened during the policy period, then the insured, the policyholder, had met their burden of proof. And then it's up to the insurance company to point to something that is excluded under the policy to completely deny coverage outright.
Chris: One thing I'll add to that, and for those of us listening to this podcast who are not like the speakers here, major insurance nerds and aren't familiar with standard policy language, there is an exception to this concurrent cause doctrine. And I touched on it briefly before. If there is policy language that precedes a particular exclusion, or in most cases, it'll precede an entire section of exclusions. And that language purports to get rid of that concurrent causation doctrine. In other words, remove it from application to a particular loss because it excludes any loss in which a particular exclusion contributes at any point in the causation chain. That language is going to be enforceable and the concurrent cause doctrine is not going to apply. If you're looking at your policy, the language is fairly standard across the board, but there are some variations. One example would read something like this. We do not cover, quote, any loss that is contributed to, made worse by, or in any way results from the below exclusion, regardless of any other cause or event contributing concurrently or in any sequence to the loss. So if you see language like that that precedes an exclusion, call it a, it's not typically in front of this particular exclusion, but say you have that language and then following that is a construction defect or faulty workmanship exclusion. Typically, if under the concurrent cause doctrine in the absence of this language, as Matt mentioned, if a loss is caused by a covered event, call it a fire, call it a hurricane, in part, and in part a construction defect, In that example I gave with the leaky windows, let's say the windows weren't built correctly or they weren't installed correctly. Under the concurrent cause doctrine, if that hurricane made that construction defect worse and the resulting damage worse, that would be covered. ] if because the construction defect contributed in any part of that causal chain, regardless of any other cause contributing concurrently or in any sequence of a loss, that loss is not going to be covered. So if the insurance company drafts the policy in a way to defeat the concurrent cause doctrine, that's going, at least in Florida, that is going to be enforceable and that doctrine will not apply to support coverage in that case. And similarly, for the efficient proximate cause doctrine, that is a doctrine, again, it's in a lot of states, California, I'll use it because we're talking about law of fighters. There is a prohibition in California law against contracting around the application of the efficient proximate cause doctrine. So in the example I gave earlier with the fire and the ash and the water, if there's an exclusion that says, well, if the policy covers fire, but there's an exclusion that says, well, we don't cover fire to the extent it combines with water to cause water damage, there's a good argument that that type of language is an attempt to contract around the efficient proximate cause doctrine. And under California law, any attempt to do that is forbidden and policy will not be enforced in that way.
Matt: All right. So let's assume that we've got our claim. We've looked at our policy. We have some understanding as to how these causation standards are going to work. Now it's time to start dealing with the insurance company. Chris, you want to talk about that a little bit?
Chris: Sure, sure. And what Matt's referring to is sort of, okay, what happens after a law? What are the conditions required? What are the obligations of the policyholder, the claimant, the insurer, the person making the claim to the insurance company? What must the policyholder do to, one, perfect, to make a claim, perfect coverage and ensure that during the claims process, they're doing everything that they are contractually required to do to avoid any excuse by the insurance company to deny coverage aside from the actual existence of coverage itself? The first step is obviously going to be notice. And Jess and Matt can vouch for this. I can't tell you how many times we've come across cases where, for one reason or another, notice was not timely provided to the insurance company following a loss. And under property policies, they're called their occurrence-based policies. And not to get into the weeds, but what I mean by that is there's occurrence-based policies where, in a property context, the relevant policy is the one in which the property damage took place during that policy. So when the property damage occurred during one policy, that's the policy that's triggered. And typically, the notice provision under that type of policy is going to be to provide notice as soon as practicable, as soon as reasonably practicable. Occasionally, you'll see the requirement that notice be provided immediately upon discovery of a loss. And that should be distinguished from claims made and reported policies in the sense that, well, notice is still required finally and it seems practicable if a claim is made during a policy period and not reported to the insurance company during that policy period or some extended reporting period that's purchased, then there's not going to be any coverage. You don't have that same claims made and reported in the policy period issue that you do for current type policies like property policies, because many times the loss isn't even ascertainable immediately. So typically, the notice requirement is going to be as soon as practical after a loss. And most it's going to be after you after you discover the loss. Now, the law on that in terms of when a notice obligation accrues can vary by state. So you'll want to check that. But generally speaking, that's the requirement under a property policy. So assuming notice is timely, the insurance company is inevitably going to ask for information. They're going to ask to come out to inspect the property. Of course, they're going to ask you most likely for documents in the event of a case where you're dealing with allegedly pre-existing damage. They're going to look for receipts and invoices for prior repairs. They may look to your email, the correspondence, you know, identifying the prior damage. They're going to send engineers out to investigate. Most policyholders, if they're in a dispute with their insurance company, they're going to want to hire their own engineers. They're going to ask for documents. They're going to inspect the property. They may ask you for what's called an EUO or an examination under oath, which is kind of like a deposition in a case, except there's no rules of evidence applicable. And an insured compliance with these requirements is critical because if there's not at least substantial compliance with these what are called post-loss conditions, the insurance company may have ground high coverage, even if the loss is covered. If you don't cooperate with their investigation, if you don't provide documents, or if you don't timely notify them of the claim, there are bases to deny cover. Now, one point I want to focus on is the document request, because the candidate insurance companies and their counsel often have a tactic, if you will, of requesting documents. You pull together everything, you send it over, followed by another document request upon another document request. And seemingly that process will never end. The insurance company will never be satisfied. And sometimes you just don't have a document, right? In most property policies, the requirement is not that you produce documents to the insurance company. It's that you make your books and records available for examination at the insurer's request. And the reason that's important, and I'll use the example of a condo association. Right. If a condo association, rather than digging through their own files, putting together everything they can and sort of dealing with serial requests for additional information from the insurance company, if instead they simply allow the insurance company to come in and access the files directly. The insurance company, more often than not, cannot complain that they didn't either get the information or if you don't have it, there's nothing you can do about it. But in my experience, having the insurance company come out and do the digging through the files themselves cuts short the document process significantly, even with most of the requesters on the insurance side. The one piece of advice I'll give for condo associations in particular is a lot of times you'll have resident personal files, whether it was the application process, you may have financial information, other personal information, social security numbers and things like that. You'll want to be sure you enter into one silo that information in a different place and make sure that you're communicating with your insurance company or council about that issue. And more often than not, they're not going to have a problem with that. So silo the confidential information, get a confidentiality agreement, and then make the balance of the files concerning the property available for inspection. You'll save yourself a lot of time and headaches.
Matt: So let me just comment on a couple things Chris said, and I want to get Jess, your reaction, and Chris, your reaction to this. There's a tension in my experience between what the policyholder is required to do under the policy and what basic claims handling standards and duties of good faith require the insurance company to do. Obviously the parties here have divergent goals. I've never met a policyholder who doesn't want their money yesterday and want the claims process done as fast as possible. Not to say it happens all the time, but sometimes insurance companies have incentives to see things and do things a little bit different. So I'll pose this to you guys. How can a policyholder successfully navigate, those competing interests while also complying with what they have to do under the policy?
Jessica: Well, I do think one thing that some policyholders maybe assume or are quick to assume but don't realize is that while they do have some general duty to cooperate, there's also sometimes an explicit duty of cooperation in policies. But that doesn't exist in every single policy. As long as the policyholder is cooperating in the sense that they are trying to assist the insurance company with their investigation through as reasonably as they possibly can, usually that is sufficient to comply with the general duty of cooperation. When it comes to document requests, and Chris had kind of talked about it already, but it is true that insurance companies tend to just constantly ask for and request documents over and over and dig deeper into it and just you kind of get into this cycle where you need to start producing as many documents as possible. But the key question I think that is worth asking is, is this actually material to the claim itself? And if it is, then absolutely send that over to the insurance company as soon as possible. But if they start asking for things like condo owners, documents, or other kinds of irrelevant materials, it might be worth maybe pushing back on that a little bit.
Chris: Just to add to that, in general, I think the best way to navigate the balance between getting paid immediately if you're the policyholder and making sure the insurance company is satisfied with the information they have is to be an open book. My philosophy generally with these claims is that there's nothing to hide. If the insurance company wants to come out to inspect the property, come on out. Try to get it done in as few visits as you can, but come on in. Take a look. In terms of the documents, I think what I mentioned before is probably the single biggest time saver in terms of cutting through the brush on these issues, letting the insurance company come out and do their own inspection of books and records. That way they see everything that's there. They pull what they want. If they didn't pull something, then that's not your fault for not producing it. It's theirs for not getting it. So I think that's a huge, huge step towards making sure that the process runs efficiently. And then, you know, in the event they ask for an examination under under oath of the policyholder, you know, you have to sit for it and they don't always ask for it. And another tip as well. Read the policy language. It's not every sometimes insurance companies will ask for EUOs of people other than the insured. Not every policy allows them to do it again in the spirit of cooperation. You may very well want to, but if it becomes the insurance company requests become onerous and unreasonable, you would have grounds to push back if they're asking for an EUO of somebody who is not one of the people that the policy requires an EUO be provided. So keep that in mind as well. The other thing is it's called a proof of loss. I haven't mentioned that, but in a lot of some some policies require proof of loss automatically and X number of days from the date of loss called 60. Others require proof of loss within X number of days, call it 60, from the insurance company's request. So keep an eye out for that. Provisions that... Begin automatically can be trapped for the unwary policyholder. They may not realize it's there. So always read your policy. But more often than not, it's going to be based on the insurance company's request. And there will be a form that you fill out. And what you should do to connect with that is provide all. If you know the amount of the claim, if you have estimates, provide that number, provide the backup. And the more information you provide, the smoother the process goes, generally speaking.
Matt: And before we move on to what you might expect after the investigation obligation is over. I just want to remind the audience, it is the insurance company's duty to investigate. Not to say that as an insured or policyholder, you should sit back and do nothing because you absolutely should not. But just remember that you need to be doing things in order to allow the insurance company to fulfill its obligations and to force them to fulfill their obligations. You know, being an open book like Chris described is one of the best ways to do that. If you remove any legitimate excuse for the insurance company not doing its job, then you're going to move your claim much faster along than you otherwise would. So with that said, Jess, do you want to talk about some of the things that happen after the investigation is over and after a claim decision is made?
Jessica: Sure. So, I mean, one thing that happens when, for example, there is no dispute that there is coverage of a claim, but there may be a disagreement as to the value of the loss. Chris mentioned this pretty briefly at the beginning of the episode, but appraisal is an informal process that can help determine the amount of the loss. So it's a great option when there is a disagreement as to the value of the loss, but there is an agreement as to there being a covered loss. We did talk about this pretty briefly in the natural disasters episode back in June. So if you want more information on that, feel free to go back there. Matt, I don't know if you wanted to talk about some additional things to look out for within the context of appraisal.
Matt: In the appraisal process for things that can slow the appraisal process down. Appraisal is designed to be an informal dispute resolution mechanism. It's designed and intended to be cheaper and faster than litigation. It can, however, be more expensive and slower than litigation. I think we've probably all seen that happen. So just be on the lookout during the appraisal process for things that might be slowing it down. There are ways to combat a slow appraisal process. You can agree to appraisal protocols, memorandums of appraisal that govern the rules. Generally, appraisal, absent some agreement between the parties for a set of rules, is pretty much a no-holds-barred affair. It's generally up to the appraisers and the other member of the three-person panel called the umpire, to set the parameters for how long the appraisal is going to take, what the appraisers are going to do. Whether they need to hear from any experts or witnesses who might be relevant to the issues that they're trying to decide. Think about that as you move into the appraisal process. Do you need some type of formal guardrail on the process to speed things along? Or if you have experienced appraisers, and I think all three of us have seen this before, there is a sizable stable of very experienced appraisers all over the country that do this all the time. A lot of times, They work together. They are frequent players in disputes across from one another. I think generally, in my experience, that is usually helpful to the process. And you want to see if you can set up a situation or at least get an agreement with the other side that maybe can utilize some of those more experienced folks. Chris, anything else you want to add?
Chris: I do. Let me just take a step back. As Jeff mentioned, generally speaking, appraisal is appropriate where there's a dispute over the, quote, amount of loss. What constitutes a, quote, amount of loss dispute may vary depending on the state. I'll speak from the perspective of Florida. Let's say an insurance company comes in and says, all right, I see you have a $10 million claim here. I think $9 million. First of all, we disagree with the number. We don't think that there's $10 million in damage here, but we think there's maybe a million dollars in damage caused by the hurricane. There may be other damage, but that was pre-existing or that's a construction defect, so we're not going to worry about that. In that case, where the insurance company has acknowledged that there is some cover damage, there's typically an appraisal provision in the policy that allows either side to demand appraisal. And if either side in the insurance company or the policyholder does that, it's mandatory. And the result, in terms of the appraisal panel's finding of the amount of loss, is going to be binding on both parties. The way the process will go is somebody will demand appraisal, and they'll designate their appraiser. Say the policyholder says, hey, insurance company, I want appraisal. I want to nominate so-and-so as my appraiser. And then per the terms of the policy, the insurance company will be required to respond and designate their appraiser within a certain number of days, 20 days, say. But once there's two appraisers selected, those two appraisers will, between themselves, select a third appraiser or the umpire, who, in the event there is not an agreement during the appraisal process on the amount of loss between the two party-selected appraisers, the umpire will decide. That'll be the deciding vote, if you will. And as long as an appraisal award is signed by two out of the three, then it's a done deal and it's binding on both parties. In terms of what constitutes or what's what the scope of appraisal is in Florida, an amount of loss dispute can include the cost. So, for example, you can get an appraisal award that says, I find that there is X million dollars in damage caused by Hurricane Beryl, using a recent example. In that case, the appraisal panel's determination of the amount of loss caused by Hurricane Beryl is is part of the amount of loss dispute. view. It is pure issues of coverage. In other words, whether a loss is excluded or covered under the insurance policy, that is not fair game in the appraisal process. That is an issue that has to be resolved by the court. I should also mention that just because the parties participate in the appraisal process and there's a binding appraisal award does not necessarily mean that the loss is covered. An insurance company may very well turn around and say, OK, great. The appraisal panel said there's $10 million in loss here, but we don't think it's covered. And then in that case, you're going to be either going to resolve it with the insurance company or you're going to be in court. So the appraisal process in many instances where there's at least where there's a clear cause of loss and clear and conceded cover damage in part is a great and efficient process, like Matt mentioned, to get a quick and timely resolution. But it may not be the end all be all in terms of the insurance company's decision to pay.
Matt: I think a key point and a key takeaway on appraisal is it can be something very helpful to the policyholder, but it's not for every dispute and it's not for every case. You've got to analyze several different issues as to whether the appraisal route or perhaps litigation route is more appropriate if you find yourself in dispute. We talked a little bit, I mentioned a little bit earlier about insurance companies behaving badly, and we don't want to spend, I don't think too much time on this, but it is a consideration for the policyholder as you go through a claim. Regarding what you can do about that unfortunate circumstance. Jessica, you want to talk a little about first party bad faith?
Jessica: Yeah, just to quickly talk about bad faith. As Matt had mentioned, sometimes insurance companies just don't act with due regard for their policyholders best interests, and they owe a duty to policyholders to act in good faith and for the benefit of the insured. And when they don't, you know, what would they lie if they intentionally misrepresent policy language, if they underpay on claims, if they don't communicate with the policyholder, or if they abuse or intimidate the policyholder, these are all grounds to sue in a bad faith lawsuit. We are running out of time today, but I think that Matt, Chris, and I will reconvene and maybe talk a little bit more about bad faith insurance lawsuits and insurance coverage litigation as well. So thank you so much for joining us on today's episode, and we look forward to talking with you about that in another episode.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
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Reed Smith partners Luke Sizemore and Andy Muha address challenges posed by mass tort litigation and discuss strategies for permanently resolving mass tort claims through bankruptcy and corporate dissolution. They also analyze the role of insurance recoveries in these strategies.
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Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues, and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Andy: Welcome to another episode of the Insured Success podcast. This is Andy Muha, a member of Reed Smith's insurance recovery group in Pittsburgh. And I'm joined today by my colleague Luke Sizemore, also of Pittsburgh, and from our firm's restructuring and insolvency group. Thanks for being here, Luke.
Luke: Of course, Andy. I'm happy to be here.
Andy: Luke and I are here to discuss an issue that intersects our two practices, insurance recovery and restructuring and insolvency. That is how to develop a permanent solution for the challenge of mass tort litigation. And I think the best way to start would be to talk briefly about the dimensions of the challenge. Mass tort litigation has been a part of the American legal scene for several decades. The term mass torts generally refers to claims for bodily injury arising from exposure to a product or continuously repeated conditions or behavior. Often, they involve a latency element, the period after the conduct that caused the injury, but before the injury manifests itself. And because of that latency period, mass torts typically pose the specter of an unknown number of future claimants. Bodily injury claims for asbestos exposure are the prototypical mass tort, but they also include claims for injury caused by talc, opioid painkillers, silica, defective medical products, and even institutional sexual abuse. Litigation of mass tort claims is expensive. Mass tort claims are typically filed in state courts, which are becoming more unpredictable and more plaintiff-friendly by the day. Claims are often filed in a variety of jurisdictions, and coordination of the defense efforts spread across multiple states adds expense and complexity. Historically, mass tort defendants have sought to cover the costs of both defending mass tort claims and paying for settlements or judgments on those claims by relying on liability insurance, whether in primary, umbrella, or excess policies. But many defendants face a troubling reality. If the mass tort claims at issue continue to be asserted indefinitely, the cost of defending and resolving those claims may exceed the limits of available insurance. That risk often is compounded by the fact that insurers themselves actively seek ways of evading coverage obligations that the policyholder defendant believes to be unassailable. Companies with healthy operating businesses may nevertheless find themselves beset by mass tort claims arising from long-since discontinued operations or from business units that were acquired recently or distantly. And despite a healthy operating business, mass tort problems can cast a pall over the company's overall prospects for growth. And they may be an impediment to strategic mergers, acquisitions, or other types of business combinations that the company may wish to explore. Given that it's typically impossible for a company to predict when the mass tort claims against it may come to a natural ending point, it can be difficult for mass tort defendants to make long-range plans that account for those mass tort liabilities in a realistic and reliable way. So, is it possible to find a permanent solution for mass tort claims in a way that puts a final stop to the financial blood loss those claims so often cause? The answer is yes, at least in some situations. And perhaps more importantly, companies that are willing to invest in long-term planning to resolve mass tort claims can maximize both the number of options that may be available to them and to enhance the potential effectiveness of those options. And Luke, why don't you talk about some of those options?
Luke: Sure. Thanks, Andy. Strategies to permanently resolve mass tort liabilities generally center around a few central steps. The first step is confining the liability to a specific entity, to the extent that's possible. The second step is identifying and marshaling assets designated to pay claims, such as proceeds from a sale of company assets, proceeds from settlements with parent or affiliate entities, insurance proceeds, and even future distributions and dividends. And the third step is effectuating a hard stop on the claims themselves. Now, there are a number of potential options for achieving that third step, the hard stop on claims. They include several options under the bankruptcy code, ranging from a Chapter 11 reorganization to a Chapter 7 liquidation, as well as dissolution under state law. And I'll briefly touch upon each of these options at a high level. As you might expect, there are nuances with respect to these strategies that we won't delve into today. To start, the gold standard when it comes to resolving mass tort liabilities and bankruptcy is a Chapter 11 reorganization utilizing the tools provided by Section 5-24G of the Bankruptcy Code. Section 5-24G of the Bankruptcy Code establishes a specific process for permanently resolving all current and future asbestos-related personal injury and wrongful death claims. First, this process requires the appointment of a legal representative or holders of future mass tort claims. Those are the claims that have not yet been asserted, but may be asserted in the future based on past conduct. And the purpose of that appointment is to ensure that the interests of those future claimants are represented throughout the bankruptcy process. Second, the 5-24G process requires the debtor to propose a Chapter 11 plan of reorganization that has the support of more than 75% of the current claimants that actually vote on that plan of reorganization. That plan is going to require the establishment and capitalization by the debtor of a settlement trust, and that settlement trust will resolve and pay mass tort claims into the future. If the debtor can satisfy those and other procedural hurdles, all present and future mass tort claims against the debtor and certain related entities that contribute to the trust will be permanently channeled to that trust, and the debtor will be permitted to reorganize and emerge from bankruptcy with continuing business operations free from the bankruptcy mass tort overhang. Now, this strategy is likely to be more expensive and may take longer than any of the other strategies we'll discuss today. But again, the result is the highest level of protection to debtors and related parties. And although Section 5-24G was drafted only to apply to asbestos claims, bankruptcy courts have approved Section 5-24G-style resolutions for non-asbestos claims by invoking a bankruptcy court's general equitable powers. The second strategy to put a hard stop on claims is a more traditional Chapter 11 reorganization that doesn't resort to the processes set out in Section 5-24G. As I just mentioned, Section 5-24G is designed specifically to allow debtors to address potential future tort claims to the appointment of a future claimant's representative. In the event that the mass tort at issue, however, is isolated to a known set of individuals with current claims, and the debtor is reasonably confident that there are no future claims, a more traditional Chapter 11 reorganization plan is possible. That is chapter 11 case without the appointment of a future claimant's representative and the need to specifically follow the dictates of section 5-24G of the bankruptcy code such a plan would involve the creation of a separate class of tort claimants the creation of a pool of funds or other assets from which the tort claims could be compensated and the establishment of procedures by which tort claims would be settled or otherwise liquidated assuming that the reorganization plan is approved by the requisite majority of creditors, but not the 75% that's required by Section 5-24G of the Bankruptcy Code, the pre-petition tort claims would be discharged under the plan. And what would remain would only be the reorganized debtor's obligations to pay settled or liquidated claims pursuant to the terms of the plan of reorganization. And unlike in a liquidation case, which we'll discuss next, the debtor's business should be able to continue operating post-bankruptcy. That takes us to the third option for putting a hard stop on asbestos claims, and that's a Chapter 11 liquidation case. Although Chapter 11 of the Bankruptcy Code normally is thought of as the reorganization chapter, a company also may liquidate in Chapter 11. A liquidating Chapter 11 case normally involves a bankruptcy sale of any remaining operating assets, followed by the creation of a liquidating settlement trust established through confirmation of a Chapter 11 plan to resolve all current tort claims. But this process does not help with future claims. Once the bankruptcy process is complete, however, the debtor will be left as a judgment-proof entity that can dissolve under state law. And as a result, any future claimants would be left without a viable legal entity to pursue. Throughout this process, and unlike in a Chapter 7 liquidation case, which we'll discuss next, the debtor will retain control of its assets and the bankruptcy process. This process offers a path to permanently resolving derivative claims against a debtor's parent and affiliate entities to a court-approved settlement, but it also requires mass tort claimants to vote on a Chapter 11 plan. Obtaining creditors' votes in favor of a plan can require significant time and effort, which can increase the cost of liquidating a Chapter 11 case. The fourth option for putting a hard stop on claims is a Chapter 7 liquidation case. This strategy will result in the complete liquidation of the debtor and the termination of its corporate existence. Although that is the same result as a Chapter 11 liquidation case, the Chapter 7 option is often seen as less desirable because the process is not controlled by the debtor, but rather by an independent court-appointed trustee that may seek to pursue derivative claims such as bail-piercing and fraudulent transfer actions against the debtor's parent or affiliates. Although those claims can be settled as part of the Chapter 7 proceeding, the central role of the trustee in this context, plus the lack of a discharge of debts at the end of the Chapter 7 proceeding, makes this option relatively less attractive. Fifth and finally, a debtor facing mass tort liabilities could dissolve under applicable state law. Dissolution statutes vary from state to state, and within each state for different types of business entities. But many of these statutes do include a bar of repose of any claims not filed within a certain time after the entity dissolves. And so the aim of this strategy is to dissolve the entity with the liability, and then take advantage of the statute of repose to cut off all remaining claims. Our Mass Tort Resolution Practice team at Reed Smith has assisted clients with implementing strategies involving dissolution, liquidating Chapter 11 cases, Section 5-24G model Chapter 11 cases, and traditional Chapter 11 reorganization cases. And in every one of these engagements, we've been able to leverage not only the firm's experience in restructuring and reorganization, but also its insurance recovery practice. Because as Andy will discuss next, insurance is intrinsically intertwined with resolving mass tort liabilities. Andy?
Andy: That's right, Luke. As we mentioned earlier, mass tort defendants traditionally have relied heavily on liability insurance to fund the defense and resolution of mass tort claims in the tort system. And one of the greatest concerns posed to many mass tort defendants by their mass tort litigation challenges, especially where the the mass tort at issue is anticipated to give rise to an undetermined and unpredictable number of claims into the future, is the possibility that the claims the defendant faces now and will face in the future ultimately might outlast whatever insurance the defendant has for those claims, whether as a result of the exhaustion of coverage limits or due to risks of insurers prevailing in disputes over whether they have to provide coverage for those mass tort claims. As such, insurance is almost always a significant factor, if not the most significant factor, in an analysis of how a defendant should try and deal best with its mass tort claims. The importance of insurance recoveries in these kinds of situations is probably obvious. Insurance recoveries are usually the chief source of funding for a defendant's strategy to permanently resolve its mass tort claims. And to one extent or another, each of the strategies that Luke discussed just a minute ago offer potential benefits for the insurers that may incentivize them to be willing partners in the policyholder's quest to achieve permanent resolution of those claims. For example, Section 5-24G model bankruptcy cases offer the highest level of protection not only to the debtor policyholders themselves, but to participating insurers as well. Section 5-24G of the Bankruptcy Code expressly provides that the channeling injunction issued for current and future claims can be extended to protect a debtor's insurers. Insurers most insurers view this protection as being more extensive than an injunction the insurer could receive by repurchasing insurance rights from its debtor insured through a bankruptcy court approved settlement which i'll discuss in more detail in a moment for that reason insurers may be willing to pay more for the protection they receive in a section 5-24G model case than in other types of bankruptcy cases. Non-section 5-24G model liquidating bankruptcy proceedings, that is a Chapter 7 case or a liquidating Chapter 11 case, offer the promise of an effective end to claims though without a permanent channeling injunction. This positions an insurer to better assess its total potential exposure for coverage of those claims and then to reach an agreement that liquidates and resolves that coverage exposure fully and finally. Possibly even more attractive to the insurer is the ability to buy back the insurance it issued to the insured, subject to the approval of the bankruptcy court. Under the bankruptcy court's provisions governing sales of property of the bankruptcy estate, which would include the insured's insurance rights, the court order approving that kind of agreement can include an injunction that protects the settling insurer from any claim that any party can make against the settled policies. In this way, the insurer can get its own finality with respect to the policies at issue. And I want to note that these benefits are also available in traditional Chapter 11 cases for situations involving a finite number of tort claims, as Luke described before. In the context of a corporate dissolution, the effect of the legal bar of repose against mass tort claims will mean that once the bar takes effect, no new claims can be asserted against the defendant insured. And as in the context of a liquidating bankruptcy proceeding, this will enable an insurer to more easily and accurately quantify its exposure to coverage for claims the insured would make for those underlying mass tort claims. And that, in turn, will give the insurer confidence that its own exposure for coverage obligations will have a definite endpoint. And this may encourage the insurer to support the insured through its dissolution process, such as by agreeing to a coverage-in-place agreement to fund the defense and resolution costs for all non-barred claims, or by agreeing to a policy buyback settlement that is priced according to the exposure that is limited now by the legal bar of repose. Because the bar alleviates uncertainty about the number, duration, and cost of future claims, an insurer may be more willing to cooperate with its insured in reaching an endpoint for both itself and its insured. Once again, our Reed Smith Insurance Recovery Attorneys have been active in recovering insurance to facilitate permanent mass tort solutions for a host of clients over the years. Not only do we know the issues, we know the insurer counsel who very often are involved in many of these cases. Our experience has been seen by clients as a significant value add to their process of effectuating a permanent solution to their mass tort issues.
Luke: Andy, I think it's important to note for our listeners that the strategies we've discussed today aren't necessarily a good fit for every mass tort defendant. The feasibility and attractiveness of these strategies depend on a host of factors that are specific to each defendant, and those factors must be evaluated before a defendant adopts and implements any particular strategy.
Andy: That's a good point, Luke. And I think it's equally important to note that defendants themselves can take actions that could make one or more of these strategies more feasible and more attractive. But this is truly only if the entity begins evaluating and planning before the number or severity of the mass tort claims at issue become overwhelming, and well before the entity finds itself running short of insurance or other assets to pay for the defense and resolution of those claims. For example, in some cases, advanced corporate restructuring may be needed to isolate the irrelevant liabilities and assets within one part of the corporate organizational chart without creating or enhancing risks of extended liability on theories like veil piercing and fraudulent or voidable transfers. In other cases, corporate families that are seeking to expand through acquisitions may need some guidance on structural issues where the target may be bringing along mass tort liability exposure so that the risks from that exposure can be contained for potential resolution after the acquisition is complete.
Luke: I agree, Andy. There's a lot to think about when it comes to a company facing these liabilities. And in light of all of this, I think one thing should be clear. Timing is really of the essence. Companies that begin thinking about these issues earlier rather than later will find themselves with more options, which are more attractive and feasible. By contrast, those who wait too long, such as until the number of pending claims is rising while their insurance for those claims is nearing an end, will have fewer uniformly less attractive options and will be forced to choose the least worst one.
Andy: That's right, Luke. And I think if one were to look for a single takeaway from our discussion today, it would be this. For any company with mass tort issues, issues the message is don't wait until tomorrow to start thinking about how to permanently resolve those claims start working on that problem today. So with that i want to thank all of our listeners for joining us and i want to encourage them if anyone has any questions about mass tort claims, challenges and potential permanent resolutions for those challenges to please contact Luke or I and we would be happy to discuss that with you. For the Insured Success Podcast, this is Andy Muha and Luke Sizemore. Thanks for listening.
Outro: Insured success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcast and reedsmith.com. To learn more about Reed Smith's insurance recovery group please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
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Lisa Szymanski and Catherine Lewis are joined by Elizabeth Vieyra to discuss topical issues related to insurance towers and how policyholders can take steps to manage the issues that can arise in complex insurance programs.
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Intro: Hello, and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues, and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist. Lisa: Good morning, and welcome back to Insured Success. My name is Lisa Szymanski, and I am joined by my colleagues Catherine Lewis and Liz Vieyra to talk about some topical issues relating to insurance towers and how policyholders can take steps to manage what can often be very complex towers of insurance. On this podcast, we are sharing our views across international offices. Great to have you both here with us. So the majority of Reed Smith's clients are international clients operating across jurisdictions and seeking insurance for a wide range of risks. Our clients very often have a need for high limits. For example, they may operate in particularly risky sectors, by way of example, the energy sector or the transportation sector, where a loss has the potential to be catastrophic and therefore pierce multiple layers of a tower. Capacity reasons may make it necessary to approach multiple insurers in multiple markets. There may be limited capacity in certain markets. For example, D&O has seen high claims volume of late, and some years have high numbers of natural disasters, which squeeze the property market. Accordingly, it is not uncommon to have a range of London market, Lloyd's Syndicates, Bermuda, and U.S.-based insurers on any given risk. There may be local law issues which require placement of a primary policy in a certain jurisdiction, which is then reinsured in one or multiple global reinsurance markets. We will split this podcast into a few sections. First, we will discuss issues relating to continuity of cover. Second, we will look at issues regarding continuity of approach in the event a dispute occurs. For example, issues of governing law and forum. And finally, we will summarize our top tips for policyholders. But before we get into the detail, Catherine, could you tell us what we mean when we talk about an insurance tower?
Catherine: Right. So I'm going to assume that our listeners are all familiar with insurance generally. What we typically see is a primary policy or even a captive policy, which will respond to the first amount of loss over any deductible up to an agreed limit of liability. As you say, Lisa, the majority of our clients are major international companies with complex insurance arrangements. A single policy and a single limit of liability may be unlikely to provide them with the full cover that they need. And as you said, Lisa, there's a whole range of reasons why a policyholder may need more cover than a single insurer is able to provide. So these additional policy limits might be achieved by purchasing additional individual policies with different insurers which sit above the original policy. So for example, a primary policy might provide 50 million US dollars of cover, the next layer might be a further 25 million US dollars in excess of the original 50 million. And you might have a further layer providing an additional 50 million in excess of the 75 million dollars we've already talked about. So on that analysis, the tower would provide 150 million dollars of insurance cover in total. Ideally, the policies higher up the tower, but not always, which are written by different insurers are done so on identical terms as the primary policy. But I mean, we can discuss this in some more detail in a moment. There are some problems that can arise.
Lisa: So as I mentioned earlier, the first topic we are going to discuss concerns continuity of coverage and issues that might arise where the scope of coverage is different in different layers and different policies. Liz, could you you tell us a little bit about your experience of these types of issues that can arise?
Elizabeth: Sure. So if I had to kind of bracket it in two buckets, I think the two areas of discontinuity I've seen are regarding coverage terms, so the substantive coverage terms, and also regarding dispute resolution terms. So regarding coverage terms, I've seen towers in which certain layers of coverage above the primary incorporate unique requirements or limitations. Limitations so an example of a unique limitation might be an exclusion incorporated in one layer of coverage that's not in the primary another kind of unique requirement for example might be a requirement for attachment so it's not uncommon that a layer of coverage would include a requirement that underlying coverage have paid full limits of liability before it attaches but that kind of requirement might not necessarily be in an underlying layer an underlying layer might say something like, just that the policyholder have had to incur cover laws before attachment of limits. So this kind of continuity, a policyholder would have to be mindful of it when thinking about settling underlying layers. And as to dispute resolution, it may occur that policies in the same tower are subject to different laws and different jurisdictions. So as both you and Catherine discussed, insurers are often from different jurisdictions, and that insurer might might have a requirement that the policyholder agree to accept the law of its jurisdiction. But if the primary policy has a different law in a different jurisdiction, the policyholder might find themselves in a situation where they can't join all the insurers in a single action in a single forum because of the differing requirements.
Catherine: That's incredibly interesting, Liz. Thank you. I mean, just from a kind of English law perspective. We see very much similar things and some examples that come to my mind that it's not uncommon for certain jurisdictions for a policyholder to be required to have a local policy in place within its global insurance program. So for example, in Japan. But from our perspective, it's always ways important that where possible, the cover afforded under any local policy is replicated in any sort of further insurance tower or within the global program to ensure the point that Liz was making about having continuity of cover. The other issue I see arising, which goes to the second point, as a matter of English law, policyholders and insurers have various obligations under the Insurance Act. The Insurance Act is a broad topic for another podcast, but in essence, there are various obligations on policyholders to make a fair presentation of the risk that's to be underwritten, which on its face may be more burdensome than in other jurisdictions. However, there are also limitations on the remedies available to insurers and specifically limitations on the circumstances in which an insurer can avoid the policy. So clearly, to have different remedies available under different layers of an insurance tower, depending on the governing law of that policy or indeed different obligations owed to the various insurers when you're placing the policy can cause a policyholder quite a headache.
Lisa: That certainly seems to be the case. So I think the takeaway here from what I'm hearing you both say is that it seems very important for policyholders to work closely with their brokers when their insurance is placed to ensure that the broker fully understands the nature of the policyholder's business and to ensure that the policyholder fully understands the nature of the protection that they have purchased. One point that I can raise in my experience is that you should make sure that you receive the policies promptly after the inception of the policy period. So, for example, I've seen situations where the policyholder thought all of its disputes would be litigated in court based on what binders of the various layers of coverage said. But once the actual policy was issued, and it was issued much later after the loss had occurred, in fact. One of the layers said something different and required an arbitration. Thus, the policyholder was very surprised to learn that it needed to arbitrate in a foreign forum. I've also seen situations, which I think Liz touched on, where a key exclusion appeared in one layer but not in others, and that had quite a big impact on the total recovery throughout the layers. Once a loss happens or once a dispute around coverage for that loss occurs. Policyholders may be in for a surprise if they don't have a solid understanding of how the layers in their insurance tower fit together. So try to be mindful of that on the front end. And the second topic for today's discussion is looking at issues surrounding the continuity of approach in the event of dispute. And Catherine, I think you have some recent experience in this field. Could you tell us what your English law view is?
Catherine: Certainly. In complex insurance tower situations, it might not have been possible, or perhaps, as you say, Lisa, the policyholder might be unaware, well, that there are not the same governing law and jurisdiction clauses in each policy layer. For example, and we've touched on this briefly, the first few layers might have a clear governing law and jurisdiction clause in favour of local courts, but perhaps for capacity reasons, additional cover was obtained in London or Bermuda or other US insurance markets, and insurers in those markets might have insisted on their own law and jurisdiction clauses. In addition, insurers might seek to include either arbitration clauses or insist on the jurisdiction of the English clause, or it might be a Bermuda form policy, which is broadly a New York law governed policy, but the procedural aspects of the arbitration is governed by Bermudian or English laws. Causing that, even if there are consistent arbitration clauses across policies, due to the confidentiality attaching to each arbitration, even if you have what looks like aligned dispute resolution clauses across your programme, a policyholder might find it difficult to read agreement with the insurers to have all of those coverage issues determined together due to the confidential nature of each individual arbitration. In our experience, there is usually very little incentive for an insurer to save the policyholder money if there is a coverage dispute.
Elizabeth: Right. There may also be differences in the procedural requirements across different jurisdictions. So speaking about the costs and the burden on the policyholder, discovery in U.S. courts is typically more extensive as compared to disclosure and arbitration. For example, under some arbitration rules, parties don't conduct depositions at all. rather they just prepare written witness statements. So a policyholder undertaking proceedings regarding the same tower of coverage but concerning different layers of insurance and in different forums may have to duplicate efforts particularly in the area of discovery because of these different procedural requirements.
Catherine: Exactly Liz, as we all know the last thing one of our clients needs when it has suffered a serious loss and where coverage is being challenged is to have to resolve the issue of the governing law or the court in which the dispute should be heard.
Lisa: I totally agree with that, Catherine. I have had multiple proceedings for a client arising out of a single loss over the course of years because the insurers were not willing to proceed in a single arbitration. This is not only costly, but it takes more time for the client to receive payment as the policyholder has to wait until all the arbitration from their force to be paid in full. We should also be mindful of the risk of inconsistent coverage decisions in different jurisdictions. While the decisions of an arbitration panel are confidential, court decisions are not. The additional impact of inconsistent decisions mean that there is a risk of gaps in cover, with some of the loss being suffered effectively being self-insured or uncovered. So, on to some practical tips. This all sounds incredibly daunting for many insurers, but it is possible to navigate some of the challenges. Liz, could you tell us what some of your top tips are?
Elizabeth: Right. So I probably have three big tips that I would give to a risk manager or someone purchasing a tower of insurance. The first one would be to have clear contractual policy documentations in place with all the operative terms in a single agreement. And if that can't be done in a single place. So, of course, it's very common for excess layers to incorporate terms from the primary policy. That's called follow form and is standard and, in fact, probably ideal. Deal and for policy documents to reference schedules or other external documents. So this is a perfectly standard practice, but it's just important for the policyholder to make sure to maintain final copies of all of the operative documents so that there is not a confusion about what terms are incorporated. The second tip is to liaise closely with brokers and make sure the brokers understand the risk and your business. This is just an important step for any kind of coverage, but particularly with purchasing a tower of insurance, the broker has to understand the policyholder's business to align the coverage with what the risks of the business are. And the third tip I give is to align governing law and jurisdiction throughout the tower as far as possible to avoid the fights and the kind of duplicative costs that we described earlier. This might not always be possible. Many insurers require that a policyholder agree to litigate disputes in the insurance company's forum. But to the extent it's possible, it's ideal. And where it's not possible, the policyholder should just be aware.
Catherine: I completely agree with these, Liz. And as you say, I'd add that it's not always practical to avoid approaching insurers in different markets. Sometimes it's absolutely necessary in order to get the best capacity at the best price. When it comes to renewal, the priority is often achieving the lowest premium for the maximum cover and depending on the risk in question a policyholder might have limited options in terms of capacity. As you say it's always key to be aware of what it is that is being purchased and the terms of that. Another tip of mine is to try and maintain some consistency with the insurers on the tower so far as possible year on year. Where I'm coming at in terms of the advantage of this is that it ensures that insurers keep some skin in the game. So if there is a big loss in one year, an insurer will be more motivated to reach an agreement or a settlement on that loss if they are still on risk in other years. Even if it's not possible to keep the same insurers at the same level, so it's not impossible to keep your primary insurer or your first or second excess at that level for numerous years, keeping them in the tower even at a higher access layer might mean that they can be brought to the table to discuss losses on other years.
Lisa: Thanks very much, Catherine and Liz. I think the two ways from this morning's discussion are, first, policyholders should ensure that they work closely with their brokers. They should make sure their broker understands their company's business, as well as its objectives and preferences. Second, at the time of placement or renewal, policyholders should be sure to be engaged in the process. ask questions to ensure that you are making an informed decision about what you are purchasing. And I think this goes to the point that Catherine just raised. For example, we understand that premium considerations are sometimes driving the deal in terms of saving a little bit of premium versus being an insurer who's been on the risk for many years in the tower. You want to make sure you fully understand the costs and benefits of saving some money versus keeping an insurer in the tower who's been there for a long time. And finally, third, in the event of a loss and a subsequent dispute about that loss, neither of which we hope occurs, hers. Policyholders should consult with an insurance coverage team like that at RedMet that has expertise across the globe so that we can, you know, present a unified front and assist you with, you know, a law that may have happened, for example, in Canada, but that implicates policies in the U.S. and London. So thanks, everyone, for listening to today's podcast, and we hope that you enjoyed this episode.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
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Reed Smith insurance recovery lawyers, Richard Lewis, John Ellison and Jessica Gopiao discuss the complexities of handling insurance claims after natural disasters. This episode covers critical topics such as the nuances of replacement cost insurance, business income coverage, and the impact of wider effects of losses in mass catastrophes. They also discuss the foundational issues in property insurance, the importance of timely communication and documentation, and the role of forensic accountants and brokers in expediting claims.
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Intro: Hello, and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues, and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Jessica: Good morning, afternoon, or whatever time it is for you, and welcome back to Insured Success. My name is Jessica Gopiao. I am a senior associate and member of the Reed Smith's Insurance Recovery Group based in both Miami and Orange County. I am here with Rich Lewis and John Ellison, and we'll let them introduce themselves before we get started.
Richard: Hi, I'm Rich Lewis. I've been handling property and business income cases for about 30 years. Handled them from 9/11, Katrina, Rita, some of the storms in New York, and I've also written a book on business income insurance disputes that I keep updated and been writing it since 2006.
John: Hi, everybody. I'm John Ellison. I'm a senior partner in the Philadelphia and New York offices in the firm's insurance recovery group. Along with Rich and about 80 others of us, we handle first-party property and business income losses around the globe and have been doing it as long and probably with as much success as any other firm. So hopefully some of our experience today will translate well to assist you if you ever are in the unfortunate situation of having to deal with a natural disaster insurance claim.
Richard: All right, so just as a matter of background, we're going to be talking about first party or property insurance, and that generally covers tangible properties such as buildings and equipment and machinery and intangible property being the expectation of profit or additional costs you have to incur to keep in business. There are a number of foundational issues that come up in most property claims. The first is most people buy replacement cost insurance, And that is insurance that gives you new for old. And there is often a delta between what your property is worth when it is destroyed and how much it would cost to replace it. And what a lot of people discover for the first time with a property claim is that under policies, the insurance company only needs to front you what's called the actual cash value. And you have to arrange to get the replacement cost. And sometimes that is difficult. other issues that come up the carrier may want to repair damaged equipment or and you want it replaced in general you know if the way to handle this is to ask the original equipment manufacturer if they will honor any warranties if the equipment is repaired and they generally say they won't and if you're not put in the same position that you had prior to an event that's not the rule the rule is that you should be put in the same position. And that usually means replacement property, not repaired. As for the time element part of property, the general rule in business income is that it's to do what you would have done, but for the event. And that's, So for business income, that's the profit and the unavoidable continuing expenses. Extra expenses are expenses that you incur to keep in business, and there's usually coverage for extra expenses. One thing to note at the outset, and I think we're going to talk about it a little bit, is that disputes under property policies generally evolve over time. It's not like a liability claim where you may get a reservation of rights or a denial letter that identifies exclusions right up front. Generally, what happens in a property insurance dispute is what will be called the independent adjuster, who is usually aligned with the insurance company, will come out and visit and look at your destroyed property and will say, well, I'm going to be your ally on this. I'm going to help you file this claim. But the problem is that the carrier has the ultimate say. And so often it'll be six months to a year before the The policyholder says, I got hit in the face with a board. Everything was going right. And then the carrier denied coverage or wants to do X or Y is not what we want to do. The last point before I turn it back over is there's relatively little case law in property insurance context. My book has about 1,300 business income cases written up, and that's every business income case that's ever been decided. it. And John can tell you there's probably 1,300 pollution exclusion cases just on one exclusion in the liability context. So that allows both the carrier and the policyholder to have some room for maneuver and some creativity as to how they approach resolving the claim.
Jessica: So the next thing that we're going to talk about is what to do in the short term. As I said before, I'm a part of the Orange County, California office in Miami office. Our practice handles a lot of hurricane claims in Miami, as well as wildfire claims in California. The hypothetical year is say a wildfire or hurricane comes through, what is the first thing that you should do? Review all potentially applicable policies regardless of title. So if you have a first party property insurance policy, that's probably the most straightforward policy that you would look at. But take a look at your entire portfolio and try to see if maybe that could also provide coverage where available. Another thing is to just pay attention to the coverages and limitations relative to that particular type of natural disaster at issue. you. And then understand that policyholders are typically obligated to comply with certain conditions or duties. So the first step, review your policies. The second step, one of the most straightforward and typical obligations that an insured has is to provide notice as soon as possible. So give notice ASAP. A lot of policyholders make the mistake of waiting until they have all the information before providing notice. Just don't do that. When preparing a notice, make sure that it's in writing, and include as much information as you have at that time, and then maybe like a catch-all to provide for all other losses that could be discovered after you do a little bit more investigation. You can always supplement your notice with information as it goes along, provide updates once that's available. Because ultimately, there's no harm in providing notice. But then on the flip side, the failure to do so can preclude coverage. The last thing that I'll recommend before I flip it back over to Rich is we just always recommend immediately gathering whatever documents that you may have for any financial or business impacts caused by the event. Because it's not just property damage that could be covered under your policy, you can also get something like business income coverage, or extra expense coverage. And then just briefly, business income coverage is designed to pay for the policyholder's loss of profits and the policyholder's unavoidable continuing expenses as a result of that natural disaster or whatever that covered event is. In this episode, we're talking about natural disasters. The other one is extra expense coverage. So that pays for both the policyholder's costs to mitigate or avoid or minimize the business income loss. And then And depending on the form of your policy, you could also have coverage for the costs that the policyholder would not have incurred, but for that loss.
Richard: Yeah. And as to highlight something Jessica said, you have to look at every type of policy that might apply. One of my first big property cases was under an inland marine policy, which seems like a contradiction in terms, not something I would have looked at, but that's where the coverage was. Another issue that will come up very early on is whether you need some assistance in calculating your loss. And there are organizations called loss adjusters. And you'll probably, if you have an event like this, they will be ringing your doorbell or sending you emails. They are people who focus in on adjusting the amount of property damage, the amount of business income loss. So the business income is something that John will cover. That's usually a forensic accountant. The loss adjusters can be somewhat shady. You have to maybe ask somebody who's a reputable one, you may or may not need that kind of help, but they certainly know their way around property insurance policies and how to put claims together in a way that insurance companies appreciate.
John: Yeah. And so I'll pick it up there. And Rich just alluded to the use of forensic accounts, which is a pretty common practice for any, sort of sizable claim or if any business is going to be interrupted from functioning at full capacity for any extended period of time, it is highly advisable to look to involve one of the many qualified forensic accountants that are out there that do this kind of work. It's often a complicated exercise to put the claim together, but what forensic accountants who do this type, of work really bring to the table is they know how to format and collect the data and present it to the insurance company in a way that the insurance company expects to receive it. And if you have a good forensic accountant on your team. That can expedite exponentially how fast you'll get a response from the insurance company and just advance the dialogue. But one of the things you have to be careful about with forensic accountants is worry about attorney-client privilege and whether your communications are protected. And we'll get into that a little bit further down the road. But one other point I wanted to add about the policies, I mean, Rich and Jessica both said, read them, but also look for potential internal limitations periods because property claims, unlike other types of insurance, often have a limitations period built into the policy that would be shorter than the limitation period that exists as a matter of law in whatever state you're located. So you don't want to get tripped up and blow a time deadline by not being aware of of those types of provisions that exist in your policy, and they are in virtually every type of property policy. The time periods often differ, but there is almost always an internal limitation period that you need to know about from the get-go.
Richard: Yeah, and that's super important. It's called a suit limitation, and it's counterintuitive because sometimes a BI loss, a business income loss will take two or three years to develop, and the suit limitation says you have to sue within two years of the damage. It's not you have to sue within two years of the denial. It's two years of the damage. And so you have to pay attention to that. You can get an extension of a suit limitation, but it has to be in writing.
John: And always make sure it's in writing. And I wouldn't even take an email, but that's better than nothing. So let's shift quickly and we'll try and cover this really briefly. That's sort of what you do in the short term. Now, what do you do in the medium term after the loss has happened and you're trying to get your business back together? It is critical to designate somebody inside your company as sort of the point person for collecting and collating all data about loss that is being experienced as a result of the impact of the disaster. And that has to start really from almost day one. But as soon as you've sort of figured out what insurance you have and what notice you need to give, the next thing you need to do is start collecting all of the data. If you can set this up internally on your computer system, you know, have some sort of tracking ability where things get tagged or immediately put into files so they're collected in real time as they're happening because the hardest thing you will ever have to do. And unfortunately, we've all had to do this with clients before, is try and go back and recreate the costs that you incurred if you don't do that from day one. Doing that as a backward-looking exercise is unbelievably difficult and time-consuming. So you will save your business and yourself a whole lot of headaches if you set up a process early on in the adjustment of the claim so that you're getting that data collected as it's being generated. And then you have it to pass on to your forensic accountant, to the insurance company, et cetera.
Richard: Yeah, I think John mentioned it, but another thing that we found is that you try to designate someone within your organization who will be present on every call, in every meeting with the insurance companies so they'll know that people aren't telling different things to the carriers and the message remains consistent. And you also want to pick somebody, one of the things we'll say several times in here is you plan for trials so that you can avoid a trial. You don't want to go to court on these things, but if you plan it out and you pick someone who would be a competent, good witness who can take the jury through all the steps in the claim adjustment, that's planning for trial so that you don't have one. Along the same lines, what we always say is just bat everything back over the net. You will get a ton of correspondence from the carrier. Make sure you answer it in a timely manner. Make sure, and that sends a message to the carrier that you're not going to go away. One of the things that Gene Anderson, who taught both John and myself, is insurance companies ration by hassle. They deny everything or they make it very painful to collect and hope that people walk away. And people who can put up with the hassle and keep batting the ball over the net by responding to letters show the insurance company that they're not going to go away and they get paid at the end of the day.
John: Just, Rich, one other thing. Yeah, I mean, the squeaky wheel gets the grease is definitely a phrase that applies in the insurance context. So don't be bashful about seeking the coverage you're entitled to get. One other thing I just want to mention real briefly before Rich moves on to the next topic is make sure you have your broker involved in the dialogue too. Because of the different roles that people play here, forensic accountants, people who work at the company, outside counsel, et cetera, the one entity that can really speak to your insurance company on a business level is your broker. And many of them have some leverage to be used on your behalf to get a claim paid. They also have channels of communication inside an insurance company that other people do not have. So an important part of your team, in addition to all these other disciplines, is your insurance broker. And they often can move things in a way that other entities can't. So make sure they earn their money.
Richard: Yeah. And the last thing with regard to correspondence is what you want to do is preserve your room for maneuver and try to pin the carrier down. I had a case one time that involved one of four cereal manufacturing plants in a city. It burned down and the carrier thought, well, we have to look at all four plants together and what their performance was because the carrier thought, well, the other three will pick up the slack. And that's not what happened. And the disruption caused by trying to get a fourth factory back online caused the other three to lose business. And when we learned that, the carrier was already pinned down by their position in writing. All right, so let's switch over and maybe we talk about other mass catastrophe issues. And maybe John can start us off with, you know, what happens with carrier positions in a mass catastrophe.
John: Sure. Yeah, well, this is a perfect segue from what Rich just said. Often insurance companies, you know, your business will have its one and only, hopefully one and only claim related to a natural disaster. But, you know, let's pick on Travelers today. If Travelers is selling insurance in South Florida when a Category 4 hurricane hits, they are going to have thousands and thousands of claims rolling in at the same time where you have your single claim. So what do you do to sort of advance the ball? One is communicate promptly and regularly to make sure you stay on the radar screen of the insurance company. And the other thing you can do, which was what Rich was just saying, is force them to take a position. In addition, policyholders are entitled to get an answer from their insurance company in a reasonable period of time. We usually qualify that as 30 to 60 days, something along those lines. There is nothing that prevents you from forcing them to answer your questions and take a position on what kind of coverage they're going to provide you or why they are not going to provide it. And again, the squeaky wheel gets the grease. So stay at it. it's not fun to do it takes a lot of commitment and time but believe us from having lived through these claims for decades now and trying to help people get what they're entitled to the more you push the more you're going to get back that's just the way it works.
Richard: One of the big issues that always comes up in a mass catastrophe is something that I call the wider effects of the loss. And the first time I saw this was after 9/11, where I had a client that did a lot of entertainment outside in basketball courts and tennis courts and golf ranges over on the west side of Manhattan. And the carrier came to them and said, well, you know, the first week after 9/11, everybody was watching CNN, so we're going to give you nothing for that week. The second week, we'll give you half of your BI loss because people were starting to get back out. Third week, we'll give you three quarters. And the fourth week, we'll give you the full loss. They had a 30-day civil authority claim. And the policyholder said, well, yeah, okay, that sounds right. That sounds fair. And that is exactly the opposite way in which carriers had handled the wider effects of the loss. lost. Historically, they've looked at the expectation as of the moment before the loss. But this issue can be huge. Look at the way Katrina affected. Almost all the carriers involved in Katrina claims in Houston and New Orleans said, well, there were no people there. Everybody left New Orleans. So we're only going to give you half of your BI claim. And that, again, is contrary to the way the carriers had handled these claims historically. And that is one of the reasons that I'm sure we're going to talk about in a few minutes, why you should consider getting some expert help early on. Because a lot of these issues, these legal issues are not intuitive. They sound, you know, if they're presented to you in a reasonable way, a reasonable business person may say, okay, yeah, that sounds right. But it's contrary to the way in which the law has said these things are to be calculated. Okay. A couple other big issues that sometimes come up, shortages in labor. So, you know, the carrier will say, well, a BI claim is usually measured in the hypothetical time needed to repair something. Well, what about in Katrina or some mass catastrophe where there's not enough labor or materials to build it? That is that you're entitled to consider that. You're entitled to consider that when making your claim. It's not hypothetically, had there been no hurricane, but it's hypothetically based on the conditions that exist on the ground. Another issue that comes up frequently is the value of location. So, for instance, it came up in a famous case called the Duane Reade case, where the Duane Reade had a store in the bottom of the World Trade Center, which was destroyed. And the carrier said, well, we'll give you the time needed to replace the Duane Reade across the street and not in the World Trade Center, which was going to take 13 years to build. I had some involvement in that case. And that one Duane Reade at the bottom of the World Trade Center made as much profit as all of the Duane Reades combined the other Duane Reades in New York. And if you've ever been to New York, there's a Duane Reade every other block. There's probably hundreds of them. And so that was not putting Duane Reade in the position that it existed before. And so you should be entitled to recover based on the value of the original location that was destroyed. So let's switch to what you can do in the long term.
John: Yeah and what I'm about to say is not a commercial for Reed Smith, but it is a commercial for policyholder counsel generally. And that is in a natural disaster situation, you can bet your life that every major insurance carrier that is involved selling insurance in that market has coverage counsel working for it behind the scenes. They're often not visible. You won't see them in the beginning of the claim. You may not see them for a long time as the claim gets processed and the paperwork is exchanged back and forth between your business and the insurance company, but they're there, advising the insurance company on what positions might be available for them to take to minimize the payment they want to make because that's always what they're trying to do.
Richard: I have been involved in lots and lots of property claims and so has John, and I have never seen a reservation of rights letter drafted by an in-house employee. They're always drafted by counsel. So the date you get a reservation rights letter, the insurance company has counsel.
John: That's 100% true. And while I say this, and I mean this sincerely, some clients don't think, believe me when I say it, but when the insurance companies don't know that we're involved in a claim, that's often when we're doing our best work. And what that means is we can help guide the process anonymously as far as the insurance company is concerned to get you through the trappings of the policy and the hurdles and all these other obstacles that we're talking about here. Just by having private conversations with one another, the insurance company doesn't need to know you're having those conversations with us or some other policyholder counsel. And that's exactly what they're doing with their coverage counsel in responding to the things you're submitting to them. So we're really just talking about an equality of arms here. But ideally, the insurance company would never know that the policyholder has counsel involved because with the assistance that they can provide behind the scenes and out of the eyes of the insurance company, that often leads to a quicker and better resolution. The other thing it sets you up for in the event you are going to have a big fight is you can begin to protect your communications under the veil of attorney-client privilege, which would not be available if a lawyer wasn't involved. And that can also protect communications with the forensic accountants and any other sort of consultants you might need to bring in to properly put your claim together to present it in the best way possible to the insurance company. So there's lots of good reasons. It doesn't mean that the policyholder attorney who knows what they're doing won't come marching in and say, you know, like, I'm General Patton now. I'm taking over everything. You work as part of a team. Everyone has their role. And that's the best way to get these claims paid as quickly and as completely as possible. But Jess, I think is going to cover another option here that we sometimes look at, which is somewhat unique to property insurance.
Jessica: Yeah, it's another way to kind of expedite potentially getting some payment under your policy. So it's called appraisal. Appraisal is a method of to determine the amount of loss under a property insurance policy. So determining amount of loss is a pretty important term here because it's not determining coverage. It's usually when an insurance company and the policyholder agree that there is at least some coverage, but they just don't necessarily agree on the specific A lot of the property insurance policies contain an appraisal provision that can be invoked by either the policyholder or the insurance company. And in some states, including in Florida, you can try to compel appraisal by filing suit so long as the policy language determines that the appraisal is mandatory and all post-loss conditions are complied with. There are a lot of, I think, really good benefits of appraisal. Not only is it informal, but it's less time consuming. It's really not as expensive as potentially going to court. I mean, Rich had mentioned previously to prepare for trial to avoid trial. And then it also would involve an expert assessment of what the amount of loss actually is.
Richard: Right. So there is an appraisal clause in almost every property insurance policy. And one of the things you need to weigh is, you know, you don't want to get jumped in an appraisal. You don't want the insurance company to start an appraisal before you filed suit because the court will, in my experience, the court will defer to the appraisal and let the appraisal happen. And the problems with an appraisal from our perspective are, you know, the way it involves, there's an umpire and there's an insurance company appraiser and there's a policyholder appraiser. And there is a vast disparity in the experience level of insurance company appraisers and policyholder appraisers. There's one appraiser named Peter Hagen who works for JS Held who says on his website that he's been involved in 3,000 appraisals. I don't know of a policyholder appraiser who's been in more than 10, and it's very difficult to get any intelligence on who are the good appraisers or who are the good umpires. The other thing that is strange about appraisal is there's no guarantee of discovery. You will not get any files from the insurance company that show how they've valued your claim or what they've done with regard to your claim. But as Jessica said, it is much cheaper, and it is potentially faster. The last drawback on appraisal is it doesn't decide issues of coverage. So it just decides issues of amount. And the carrier can say, okay, well, we've discovered that it would be a $10 million loss, but we're denying coverage on these five grounds. And then where are you? You're stuck in the same place you were before the appraisal.
John: I think that brings us back to the line we've repeated a few times, prepare for trial to avoid trial. I always think of these as prepare for the worst, hope for the best. Most of these cases will not end up in trial. I mean, trials are a single-digit percentage of the number of claims that are made at best. I mean, it could even be less than 1% for all I know. But the insurance company who knows that the policyholder is prepared to see the claim through and is presenting its information and conducting itself in a business-like and serious manner is going to get treated better and is likely going to be able to avoid trial. Because the insurance company knows they're dealing with, in a natural disaster situation, they're dealing with thousands of other claims. We may as well make this one go away because we have plenty of other people we can pick on who aren't doing it the right way. So hopefully what we've said today gives you some pointers and useful information to put your business in the best situation it could possibly be in after suffering a terrible incident like a natural disaster. But we want to thank you for the time you took to listen to us. Jess, Rich, and I are all reachable through the Reed Smith website if you have any follow-up questions, and we'd be happy to chat or email with you. And we hope you enjoyed this version of Insured Success. Thanks very much.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation.
All rights reserved.
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Carolyn Rosenberg, Stephen Raptis and Jalen Brown explain what “bump up” exclusions in D&O insurance are, and policy considerations when considering or structuring a transaction.
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Intro: Hello, and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues, and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Carolyn: Welcome to our Insured Success podcast, the bump-up exclusion. I'm Carolyn Rosenberg. I'm a partner in our insurance recovery group on behalf of policyholders here in Chicago. With me today are my colleagues, Jalen Brown, also in Chicago, and Steve Raptis in our Washington, DC office. We'll get right into it. We've talked about the bump-up exclusion, which is a name. Jalen, can you start us off and tell us what do we mean when we say a bump-up exclusion?
Jalen: Yes, thank you, Caroline. So bump-up exclusions have become a hot issue for D&O insurance coverage. Insurers have begun raising these issues regularly in claims involving corporate mergers and acquisitions, insurers assert these bump-up exclusion claims whenever consideration paid in an acquisition is alleged to be too low. And so while a bump-up exclusion is referred to as an exclusion, we won't find a bump-up exclusion in exclusion sections. There is a carve-out for the definition of an otherwise covered loss. And so a bump-up exclusion provisions are often found within a D&O policy's definition of loss, and attempts to exclude the amount of a settlement or judgment that represents an increase in the price paid to acquire an entity where such consideration was alleged to be inadequate. There are a few exceptions to the bump-up exclusion. Virtually all bump-up exclusions carve out coverage for defense costs and side A claims, and I know Steve is going to tell us a little bit more about what side A claims are.
Stephen: Just as a little bit of history, D&O policies were originally put into the marketplace largely to protect the directors and officers from non-indemnified claims, the kind of claims that the company will not indemnify them for or can't indemnify them for legally. Those are side A claims. Many D&O policies also include side B and side C coverage that protects the company. But the side A claims are the non-indemnified claims against the officers and the directors.
Carolyn: So, Jalen had mentioned that these come into play in acquisition situations and transactions. Steve, tell us, where do you think the bump-up exclusions come into play most? What kinds of cases or situations should you be on the lookout for?
Stephen: In my experience, I've been seeing insurers assert that bump-up exclusions apply to really all types of corporate transactions. They haven't limited it to one type. It's become sort of a go-to generic defense anytime there's an allegation in a case that inadequate consideration was paid and consideration with a transaction. And that includes both public and private companies. And we have seen sort of a morphing of these exclusions. It used to be traditionally they would apply to, they would contain language that made them applicable to acquisitions. That was a key word, and often it would be accompanied with acquisitions of all or substantially all of the assets of some other entity, and that was where the exclusion applied. But more contemporary versions we're seeing have really gotten away from that acquisition language. We might call it a restriction. And we know that with most public company transactions, they will be challenged. It's the nature of the beast. And when I say challenged, one side, one set of shareholders or another will claim that either their side paid too much or the other side will claim that they didn't receive enough. And sometimes there are both of those allegations in a single transaction. They can't both be right, but we'll see both sides actually have to deal with those kinds of shareholder suits. The good news is if you're a public company, these are securities claims. These are exactly the kinds of claims that are likely to be covered if you have side C coverage. So that's the good news. And one other thing that policy holders should be aware of with respect to these bump up exclusions is they really are, even in the states where they've been interpreted in favor of the insurers, they are still limited to the language of the exclusion. And that is damages or loss where it is claimed that inadequate consideration was paid. So if the loss or the damages at issue are of a different nature, those should not fall under the bump-up exclusion. And that's something that we should all be mindful of when we're looking at these often long securities complaints that may be 150 pages long. You really need to separate out what falls under the exclusion and what doesn't, because if it doesn't fall under the exclusion, it should still be covered regardless of how the bump-up exclusion is interpreted.
Carolyn: And as you said, Steve, and as Jalen alluded to, even though this is in the definition of loss, it's an exception to the definition of loss, and therefore it is construed as an exclusion. And as we know, applying basic sort of black letter law principles, exclusions have to unambiguously apply, and the insurer has the burden to show that. So, you've told us sort of theoretically and practically speaking what's covered, but let's get into the nitty-gritty. Jalen, you know, who's been winning the coverage disputes in regard to the bump-up exclusion?
Jalen: At this point, Delaware seems to be the only jurisdiction that is scrutinizing these exclusions rigorously. Two examples of this is in February 2021, the Delaware court presented the Northrop Grumman decision, and in this case, the policyholder prevailed under Delaware law. Some of the key facts for this case was that both sets of shareholders voted, neither merging entity survived, and that neither entity obtained substantially all of the assets of the others. The court noted in Northrop that the shareholder claims did not allege inadequate consideration exclusively, and the court construed the bump-up provision, which the court deemed an exclusion, and narrowly and strictly under Delaware law, the court concluded that it applied to a lawsuit claim that alleges only the consideration exchanged, nothing else, as part of only one specific control transaction was inadequate. The court held that the exclusion was inapplicable to the merger because the lawsuit involves more than just inadequate consideration. And also more recently, we have the Viacom decision that just came down a few months ago in August of 2023. And. Again, the court applied Delaware law, and this case involved a merger between Viacom and CBS, and this was a transfer of all of Viacom's assets. The shareholders of Viacom brought a claim against Viacom due to the merger. And in this case, the shareholders and Viacom ultimately settled their claim for $122.5 million, and the insurers refused to pay the settlement because of the bump-up exclusion provision. In this case, Viacom countered the insurers and stated that the bump-up exclusion applied only to acquisitions, and acquisitions was an unidentified term within the policy and was not considered a merger. The Delaware Superior Court found that the bump-up exclusion was ambiguous as it was subject to contrary but reasonable interpretations, that the exclusion applied to acquisitions that are part of a broader transaction, such as a merger, or that it only applied to acquisition transaction. As a result of this case, the court held that the bump-up exclusion had to be interpreted in favor of coverage and that it did not apply to Viacom's settlement of the CBS merger claims. Therefore, Delaware has been the only state so far that has been rigorously construing bump-up exclusions in favor of policyholders.
Carolyn: So it sounds like, Jalen, that Delaware law is favorable, at least at this point, and scrutinizing the specific language and the particular facts are critical. What about the cases where policyholders have not fared as well? What about the cases that have been lost?
Jalen: For the cases that have been lost, those have been found in jurisdictions that have not been applying Delaware law, such as Wisconsin, Virginia, and California. An example of this case would be the Komatsu Mining Corporation decision, which was a Seventh Circuit decision in January of 2023 that applied Wisconsin law. In this case, the transaction at issue was a merger, but the extent to which the merger is an acquisition was not particularly analyzed by the court. The court held that the exclusion applied solely based on the inadequate consideration language and the bump-up exclusion policy. While the court acknowledged the Northrop decision in Delaware, it noted that the exclusion at issue was different and that Delaware law applies more policyholder-friendly rules of policy construction than the Wisconsin courts.
Carolyn: I know there was one other case as well, the Towers-Watson case, right, where the appeal was recently in the Fourth circuit, and that didn't go quite as well as policyholders had hoped.
Jalen: Yes, the Towers-Watson decision came down from the fourth circuit on May 9, 2023. The fourth circuit reversed the district court's decision and applied Virginia law instead of Delaware law. The fourth circuit relied on the dictionary definitions of the term acquisition to conclude that the term applied both both to the actual acquisition of a stock and to mergers. The Fourth Circuit then remanded the case to the District Court to determine whether the bump-up exclusion applied, given these new parameters. The District Court's decision came out on March 6, 2024, and consistent with the Fourth Circuit's opinion, the District Court determined that the contract interpretation in Virginia was distinct and different from Delaware, and that under Virginia law, the bump-up exclusion applied.
Stephen: One thing that I found interesting about the Wisconsin case and the Towers-Watson case were the fact that they found the Delaware law actually applies more policyholder-friendly rules of policy interpretation than the states, Wisconsin and Virginia, whose laws they were applying. That was interesting to me because we normally think of that body of law as universal. In fact, we often refer to it as universal rules of policy interpretation. But I thought in both cases, it was interesting that those courts distinguished the Delaware cases by saying, well, Delaware has a different set of rules of policy interpretation, which was a little bit new to me.
Carolyn: Yeah. And Delaware makes some sense because many corporations are incorporated in Delaware. Delaware seemed to have a body of law where the jurists are quite familiar with. Corporate law, indemnification, bylaws, and also the roles of directors and officers and the ability to look at transactions, look at the various damages alleged, and be able to parse through both the exclusions and elements of loss that would be covered. And although we've been talking about the cases themselves and the very helpful analysis that you both have shared, the real question too is, are there really lessons learned from either successful, partial success, or not success if you're a policyholder that could be applied when you're purchasing insurance or renewing your D&O policy or structuring a transaction or considering it. Steve, can you share some of your thoughts on those issues?
Stephen: Yeah, I guess the first thing that I would say is that this is an evolving issue because this is not an exclusion that has been interpreted in average state, or not even close to it yet, this is a book that's still being written in terms of the ability of policyholders to really effectively be able to recover under their policies with respect to transactions. But there are a few things that I think that we can take away from where we are on the current state of the law. The first thing, and just to sort of go one level higher, is that D&O policies for people who have not negotiated them, they aren't written on a standard policy form like you might have with your general liability policy or your property policy. There's not much room to negotiate those policies because the insurance industry has a form that everybody uses. D&O policies aren't like that, which means that each insurer has its own version of policy. There's a lot of similarities between those versions, but they're not the same. And as a result, depending on how the market conditions are at the time, certain provisions within your D&O policy may be negotiable. And we have no reason to believe, given that There really is no typical bump-up exclusion. That language has really evolved over time and continues to evolve over time. We don't have any reason to believe that that's not one of the provisions that may be more on the negotiable side than the non-negotiable side. But regardless, when the policyholder at renewal or if they're buying a new policy altogether, they really need to look at that language, whether it be in the specimen policy, if they're buying it from that carrier for the first time, or whether it's in their current language that they would renew. new. They really need to review that language carefully at renewal so that if adjustments need to be made, that can happen. That's the right time to do it. A couple of the things that they can look for that we've highlighted already today, if you can find, if it's still available, a version of the exclusion, it still has the traditional acquisition language in it. We mentioned earlier that that might be thought of as a limitation. That's a good thing with exclusions. If you can still get a version of that bump-up exclusion, that's a good place to start. As Jalen mentioned earlier, bump-up exclusions traditionally always carved out defense costs expressly. Now we don't always see them carved out expressly. If you can get a version of the policy that carves them out expressly, that's better than relying on certain language that may be within the exclusion that can be interpreted as carving out defense costs. We want to make sure that language is expressed. And then finally, you want to make sure that that side A carve out, which should be in every bump up exclusion, is stated very expressly. In your exclusion, maybe it says that the side A claims are carved out. Maybe it says it only applies to side B and C coverage. Either way, you would be well advised to make sure that that carve out is in there. The final thing that I would say is that a lot of times in structuring transactions. One of the last considerations that the negotiating or the transacting parties have is insurance. What we might propose is under certain circumstances, insurance maybe should be more of a driver than an afterthought. And especially, say, for a public company, it's highly likely because of the visibility of the transaction that it will be challenged on one side or both. So maybe since you know you're going into the transaction with a high likelihood that it will be challenged, maybe D&O insurance and the recoverability of D&O insurance should really be more at the forefront of the thinking. Can you structure your transaction in a way that preserves the D&O coverage if the transaction is ultimately challenged? And as we talked about a little while ago, Jalen talked about the fact that Delaware has shown itself to be a friendly place. Two different types of burgers have been held by Delaware courts not to be subject to the exclusion. So, if all other things are equal, why not structure your transaction in a way that takes you outside the bump-up exclusion, at least arguably, by structuring it, if you're a Delaware corporation, in a way that's consistent with the case's finding coverage? Anyway, we don't want to suggest that the tail should wag the dog, but D&O proceeds in these transactions, like Jalen talked about with Viacom, $122 million in D&O insurance proceeds. That's a lot. And so it's something to take into account when potentially when you're structuring a transaction, especially if you're a public company, especially if you're a Delaware corporation.
Jalen: That's a great point that you mentioned that an insurer should really consider the language of the policy that they purchased. That's exactly what the Onyx decision focused on, where the court held that and relied on the assumption that there was more favorable policy language available in the marketplace, and that was not purchased by the policyholder when finding that the bump-up exclusion did apply.
Carolyn: And clearly, bump-up exclusions are not going away anytime soon, at least not for the short term. So it's really important to both know what jurisdiction you're in, do what you can on the negotiating front and structuring the transaction, and of course, understand where the case law is and is going and really get into the facts to be able to make the arguments that put you in the best place to overcome the exclusion if and when it is raised. I want to thank both Steve and Jalen for elucidating the topic for us today and would invite you to tune in to additional episodes of Insured Success. Thanks so much.
Stephen: Thank you, Carolyn. Thank you, Jalen.
Jalen: Yeah, thank you both. It was great talking.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
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Catherine Lewis and Emma Shafton team up to discuss the UK's Economic Crime and Corporate Transparency Act of 2023 and its potential impact on directors and officers (D&O) insurance coverage. Both based in London, the lawyers discuss important steps that policyholders can take to mitigate risks.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Catherine: Welcome back to Insured Success. My name is Catherine Lewis. I'm a senior associate in our London office. I am joined today by my colleague Emma Shafton, who is a senior associate in our global regulatory enforcement group who specializes in white collar crime and investigations. Today, Emma is going to talk to us about the two new corporate criminal offenses contained in the Economic Crime and Corporate Transparency Act 2023 which came into force in the UK at the end of 2023. And we are going to share our insights on what this means for policyholders operating in the UK. The potential impact on your directors and officers and other insurance cover and some of the steps that policyholders can take to mitigate risks. Emma, could you give us an overview of this new legislation?
Emma: Sure. So the Act, ECCTA I'll refer to it as, came about as part of the UK government's response to Russia's invasion of Ukraine in February 2022. By this time, there was an increasing understanding that London had become um a dumping ground really for dirty money by foreign elites, Kleptocrats and other bad actors and that the UK's economy was being abused. So the act represents a complete overhaul of the UK government's framework for tackling economic crime. The act itself covers a very broad range of issues. You know, beyond the scope of this podcast, including companies house reforms, but today, we're going to focus on two significant changes to corporate criminal law. The first is the new senior manager's offense and the second is the new failure to prevent fraud offense. So let's deal with the first offense first. So that's the senior manager's offense and that's under section 196 of ECCTA. Uh This came into force very quietly on boxing day last year actually. Um and a lot of Corporates have been caught by surprise by it and it's worth flagging at the outset that this is completely separate to the FCA's existing senior managers and certification regime. These are different things. It's perhaps unfortunate that the draftsman of a decided to use the same language because the definitions unhelpfully do not correlate. Um So I just wanted to flag that at the beginning, we're dealing with a completely new corporate criminal offense here. What the offense means basically for corporates is that if a senior manager of the organization acting within the actual or apparent scope of their authority commits a relevant criminal offense and those offenses are economic crimes. So things like theft, bribery, fraud, false accounting money laundering, and also certain tax offenses. If that senior manager commits one of those specified offenses, the corporate can be criminally liable. Now, what the repercussions of that would be, is a very large fine. Essentially. Now, this offense um can apply to senior managers of a body corporate or partnership and there's no size criteria or threshold. So that means that all organizations um of any size could be liable so long as the jurisdictional requirements are met, you know, this is a UK act and we'll come on to that um, Later.
Catherine: Interesting, this seems like a really big shift from the previous regime. Is, is that right?
Emma: It is. So the new senior manager's offense is one of the biggest changes really in corporate criminal liability in over 100 years. So under previous law, uh which was, you know, Victorian law, um, corporates could only be prosecuted and criminally liable for the offenses of its employees if it could be shown that that individual was acting as the directing mind or will of the corporate and you know, they had the necessary state of mind for the offense in question. So with a lot of the economic crimes, usually that involves dishonesty. So historically, this made it very challenging for authorities to prosecute corporate successfully. Um because there's just a very small group of people who would meet that criteria of directing mind and will. And this is particularly so in large corporates, with complex management systems became very difficult to identify whether an individual belonged to that group. So that was the sort of historic position. This new offense essentially makes it much easier for corporates to become criminally liable for the actions of its senior managers now.
Catherine: So, I mean, who are these uh new senior managers that have been identified?
Emma: So, um this we foresee is going to be one of the issues with this legislation and for corporates in actually identifying who their senior managers are, and it's not entirely clear from the legislation. Um there's no guidance. The government are not required to publish guidance for this offense uh about this point so that the act defines a senior manager as an individual who has a significant role in the decision making of the whole or a substantial part of the corporate and someone who is involved in the actual management of the whole or part of the corporate. So it's somebody who's making decisions, really somebody who is making decisions at a high level. Um Apart from directors who are perhaps a sort of obvious class of people who would fall within this definition, other roles could include a regional manager, for example. Uh but you know, as, as I've already said, it's not clearly defined who senior managers are. And it may be difficult in practice for corporates to identify who their senior managers are because depending on the sector and the business, this may be a fluid category of individuals. We also foresee that one of the biggest challenges for prosecutors is going to be proving apparent authority. So actual authority, perhaps you might look at a job's description or somebody's responsibilities to determine what is within someone's actual authority. But what does apparent authority mean? It sort of implies that that person doesn't have authority to do um the act in question. So we think there's going to be substantial debate on this topic. And um it'll be very interesting to see. The SFO have indicated, the Serious Fraud Office that they may publish some guidance about how this new offense will be enforced. So it will be very interesting to see in due course, what they say about this. So, um yeah, that sort of is broadly um the position on the definition of senior managers.
Catherine: That's really helpful. Thank you. And so is the senior manager events limited to individuals within the UK?
Emma: So the definition of a body corporate or partnership in, in the act includes um those incorporated outside of the UK, so um it's not limited to the UK, and what this means is that a non-UK company could be liable under this act where um an offense is committed by a UK national senior manager, for example, or by a foreign national senior manager when the offense is committed in the UK. So there is certainly a degree of extra territoriality.
Catherine: Really interesting. So it seems to me that policyholders will need to be carefully considering their directors and officers insurance as well as their liability policy wording to take into account these pretty serious and significant changes. Directors of offices or D&O policy is one that a policyholder would typically look to respond if it's faced with an investigation or a potential investigation by a regulator or an authority um, in respect of the conduct of its senior management and clearly an important point for policyholders is to, as you said, Emma consider who their senior managers are and to ensure that those individuals are falling within any applicable policy definitions of individual insured or insured persons. Are we expecting to see a significant number of investigations or prosecutions or penalties being levied as a result of this legislation?
Emma: Yes, we think so. So on paper, the offense is astonishingly wide. The group of individuals whose conduct can lead to the prosecution of their company for their actions, their criminal actions has, it's really expanded the pool of people is much bigger now. And therefore, um the new offense significantly increases the risk of criminal liability for corporates but of course, um, you know, these offenses are only as good as the enforcement agencies, um, who might use them. So this offense is only going to be a game changer and is only going to see more prosecutions and so on if the agencies actually use them. So at the moment, we, we understand that the serious fraud office are, are quite excited about this new legislation. Um, yesterday, I, I heard a senior person from the serious fraud office describe it as a game changer this offense and said, you know, where appropriate obviously, they will use this offense where they can. They've had um a very bad track record of securing convictions against individuals in relation to corporate settlements and have lobbied very hard to change the law in this area. So, you know, we certainly um would expect to see them using this relatively soon in an appropriate case. And as I highlighted earlier, they've hinted that they are going to publish some corporate guidance in relation to this. So we, we await that with interest. There's definitely a sense though that the office is buoyed by this new offense. It's got a new director in place and are doing things differently. It seems so we, we can expect the SFO certainly to be looking at this offense very closely. And then from an FCA perspective, they've recently published their 24/25 business plan and commitment number one is reducing and preventing financial crime. So we would expect, you know, the FCA to be looking very closely at this new tool available to them as well. Another point to highlight in relation to, you know, whether this is going to see a significant number of or an increase in prosecutions and investigations is that there is no defense, there's no defense of having reasonable procedures in place. Uh, which is very interesting. So, um, yeah, we, I think we can expect to see more investigations and prosecutions. The penalty is an unlimited fine for the corporate.
Catherine: Wow, that's pretty, pretty significant for, for anyone doing business that touches the UK. So what can companies and businesses do to mitigate and, and reduce their risk? What steps should they be taking now?
Emma: Policyholders should identify their senior managers as, as the first port of call. And we've already explained that this may be challenging to do in practice, but that's the first point. And, and once you've identified that group of individuals, you need to consider the risks really that those individuals might do something that results um, in criminal liability for the corporate. So introducing comprehensive training relating to economic crime, money laundering for senior managers is going to be key and I've referred to money laundering and that's because it's very important to note that in addition to bribery fraud, theft and so on, there are some money laundering offenses, um, that are caught under this act, in particular in relation to the AML mandatory reporting regime, suspicious activity reports. It's a criminal offense under the process of Crime Act when a relevant person in the regulated sector fails to notify the authorities about suspicion of money laundering and under this act. Now, if that substantive offense could be made out, the corporate could also be liable which wasn't the position before. So, very significant changes here.
Catherine: Yeah, absolutely. So, moving on a little bit, then can you tell us about the new failure to prevent fraud events?
Emma: Yes, sure. This is under section 199 of ECCTA. It follows the failure to prevent model that our listeners are probably quite familiar with now. So section seven of the Bribery Act um was the first offense of this nature and subsequently, we've had failure to prevent tax evasion. The, the key difference though, in relation to this new offense and the Bribery Act, however, is that it only applies to large organizations. Section seven of the Bribery Act applies to all organizations irregardless of size. So it's a smaller pool of corporates who will be affected by this. But the definition of large organizations for the purposes of this new offense is the organization must have a turnover of more than £36 million a balance sheet total of on aggregate more than £80 million in assets or more than 250 employees. And it has to meet two of those criteria.
Catherine: Thanks, and so how does the offense work?
Emma: So if you're a relevant body, so as defined, meeting two of those three criteria, that relevant body will be criminally liable when an associate of it commits a specified fraud offense. So there are four requirements of the offense. The first is there must be a specified fraud offense. Um Those are all listed, but you know, it would be offenses under the fraud act and false accounting, fraudulent trading. The second requirement is the offense is committed by an associated person to that corporate. So associated person is a term we're very familiar with from the Bribery Act, but it's an employee, an employee of a subsidiary agent that those are the sorts of people who are associated persons. It's apparent that the SFO is taking quite an expansive view of who falls within, into associated persons and recently indicated that it's looking at whether social media companies could be liable for failing to prevent investment fraud perpetrated on their platforms, for example. So that just gives you an idea of how expensively they are looking at it. The third requirement is that the offense um is intended to be for benefit of the organization. The fraud doesn't have to be successful, uh doesn't have to 100% be for the benefit of the organization. But it's important to note that if a corporate is the victim of an employee or associated persons fraud, they will not be liable under this offense. So that's an important carve out. And then the last requirement, the fourth requirement is that no reasonable fraud prevention procedures are in place if they are. It, it's a defense. The offense itself is actually not in force yet. Um And that is because there is a requirement for the government, the home office in this case to publish guidance and, and that has not been finalized yet. There's draft guidance in circulation and the final guidance is said to be expected imminently. The offense is meant to come into force six months after the final guidance has been achieved. So um could be this year we're waiting to see um in our view though, that six month period isn't enough time for corporates to get ready.
Catherine: Yeah, I agree. That seems like a pretty, pretty short amount of time to get ready for some fairly significant potential offenses there. I asked this question regarding the senior manager offense, but does this offense apply just to UK companies?
Emma: So there's also scope for um extra territoriality in relation to this offense. It depends really on where the specific underlying fraud offenses take place. So a non-UK organization could be caught by this offense where say an employee or agent commits fraud under UK law or targeting UK victims. So the key thing is where the fraud is taking place, not necessarily where the person is, who's committing it.
Catherine: Right, That makes sense. Are we expecting then to see a significant number of investigations and prosecutions once this element of the legislation comes into force?
Emma: Given the offense only applies to very large companies. We're not expecting as many prosecutions or a significant uptick as we are with the senior manager offense. But we are definitely expecting prosecuting authorities will look to use this new tool where they can and it is possible to see joint charging because the way the legislation for the senior manager offense is drafted, it's not the case that a senior manager has to be taken to a court convicted. And only then once that conviction is, you know, confirmed, the prosecutor would then go on to prosecute the corporate. It, there's no requirement for that. So what we might see is joint charging of senior managers and corporates for the failure to prevent offense. At the same time as with the senior manager's offense, the penalty is an unlimited fine again. So it's essential that large companies are prepared for this legislation.
Catherine: Yeah, fully agree with that. Um Let's go on to about what what steps they can do to prepare. We talked about it a little bit earlier about the senior managers events, but what steps should uh policyholders be taking taking here?
Emma: The critical thing to do is risk assess so specifically focused on fraud, risk and the risk of other economic crime. And if a corporate has already undertaken a fraud risk assessment, that should be reviewed to make sure that it remains fit for purpose. As part of that risk assessment, you should be assessing your geographies, sectors, clients and suppliers. So the second thing is once you've done that risk assessment, ensure that you have proportionate policies and procedures in place to cover those risks, um identify who your most at risk employees, subsidiaries and associated persons are as part of that risk assessment, consider introducing comprehensive training for your employees, subsidiaries and associated persons in relation to financial crime risks and monitor and incentivize compliance. Those are the key things that policyholders can be doing to prepare for this legislation.
Catherine: This all sounds really critical for policyholders and I expect that it's these are the sort of questions that insurers will be asking policyholders when it comes to renewing insurance policies. I certainly think we can expect questions about the identification of senior managers as well as copies of risk assessments and reporting procedures. So any potential concerns are raised and addressed appropriately within the organization?
Emma: Yeah, I totally agree. Are there any other final points from an insurance perspective that you think policyholders should be aware of when considering the impact of the two new offenses?
Catherine: There are Emma, and I've been thinking a lot about all the really helpful analysis and explanation you've done of these pretty significant offenses and some of the key considerations I think that policyholders should have in mind entering into a renewal process since the introduction of the legislation and the two offenses are, is there sufficient investigatory costs cover? So will the policy respond to an investigation being instigated by any of the authorities? And what is the trigger for any investigation or pre-investigation costs? So at what point does the policy step in and help uh a policyholder cover any of its legal costs or investigation costs in looking into the facts and events that the authorities are also looking at. And is there an extension for any specific pre-investigation or mitigation costs? It's also worth bearing in mind what the notification requirements are under the policy in the event that there is an issue down the line when faced with an investigation or request for information from an authority that often requires a really quick response from the business. And the priority obviously will be engaging with the authorities and insurance may not always be front and center of everyone's mind in that context. It's incredibly important that any notification requirements are not unduly onerous to making sure that the policy allows for plenty of days for a notification to be made and avoiding any conditions precedent to cover in case notification isn't made as promptly as everyone would like. When it comes to D&O policies as well as having side A and side B cover protecting individuals, as corporate entities as well as natural persons can be liable under these offenses, I think businesses should be considering whether they want any side C cover as well and having a discussion with their broker about the benefits of having sort of this additional D&O cover. And a basic point but nevertheless important one checking an overall limit of indemnity, making sure that the limits of liability continue to provide adequate protection for the business, particularly in light of what you've been saying about expecting an increase in investigations as a result of the senior managers, events in particular. In my experience when there's an investigation or inquiries are being made by a regulator or other authority clients, customers, investors all tend to get pretty nervous if things lead to a prosecution or a threat of prosecution. A policyholder might also start to see some civil claims coming from allegedly injured parties trying to seek compensation, whether that's investors and shareholders or customers and clients. I think in those circumstances, policyholders should also ensure that any civil liability policies provide the right level of cover for their businesses. So that's it from Emma and I today. Emma, thank you for sharing all your insights on this important new legislation and your tips for mitigating and managing some of the risks. Don't forget to tune in to our next episode.
Emma: Yeah, thanks for having me, Catherine. It was great to chat about these new offenses and yeah, please do everyone feel free to, to reach out if you have any queries about them.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, Opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
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David Cummings and Lauren Gubricky are joined by Jeff Buzen of McGill and Partners to discuss representations and warranties insurance, best practices for making claims and trends in the industry.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
David: Hello and welcome to another episode of Insured Success. Thanks for joining us. My name is David Cummings. I'm a partner at Reed Smith in our insurance recovery group. A way of just a little bit of background. My practice focuses on navigating insurance coverage, disputes, litigation, mediation and arbitration for our corporate policyholder clients, as well as helping those clients navigate insurance placements, renewals claims and the like all with their insurers. An ever growing part of that practice involves a product called representations and warranties insurance or reps and warranties insurance. That's a topic of our discussion today. So before we get started, I have a few introductions are in order. Uh I'm joined today by my colleague, Lauren Gubricky, an associate in Reed Smith's insurance recovery group. Hi, Lauren.
Lauren: Hi, Dave. Thanks for having me.
David: I’m also joined by our guest, Jeff Buzen, a partner in financial lines at McGill and Partners. Hi, Jeff. And thanks for joining us today.
Jeff: Thanks Dave. Great to be here.
David: So, between the three of us, we're gonna cover a few topics today. So I'm gonna start and provide a high level overview of reps and warranties insurance, what it is and how it's used. Then I'm gonna pass it to Lauren who's going to focus on reps and warranties claims and a few best practices. And along the way, we're gonna talk with Jeff to provide us with some insights and trends with respect to the reps and warranties market. So with that, let's get started. So let's start with a quick overview, reps and warranties insurance. What even is it? At at a very high level in a private equity deal, we have company A, the buyer purchasing company, B, the seller. So as part of that purchase and as a result of information borne out through due diligence, the seller makes certain reps and warranties regarding its business. Those can include ongoing risks, contingent liabilities, reps related to financial statements and so on. Traditionally, to hedge against the risks of inaccurate or incomplete information, the asset purchase agreement would provide recourse to the buyer in the form of an indemnity provision and the way that works is a seller would have to back that obligation with funds in the form of a hold back or escrow uh and keep those funds in place for a negotiated survival period, often for several years. Now, the issue is that these indemnity provisions can be the source of extensive negotiations in and of themselves negotiations that could add layers of unwanted complexity to a deal. Um And that may result in delays and disagreements. And in some cases, historically, the deal could collapse entirely over, over these disagreements and these negotiations. So insteps reps and warranties insurance. This product was developed to at least in part to avoid these issues and speed up deals by shifting the risk to a third party insurance company. This allows for higher indemnity limits and survival periods without material increasing seller exposure all while being able to keep up deal pays to close quickly and not be bogged down by extensive disagreements or negotiations between the buyer and the seller. So what do these policies look like? So they can be purchased by the buyer as first party coverage or the seller as third party coverage in practice though the overwhelming of them are buyer side. The actual scope of coverage is determined by those specific reps and warranties in the asset purchase agreement and that agreement is generally incorporated into the policy itself. It's a very general matter. Although these, these policies can differ from deal to deal and insurer to insurer. The insurance covers inaccuracies or gaps in the reps and warranties that cause loss or liability to the buyer and although the exclusions too can vary depending on the specifics of that deal and the industry and the reps and warranties at issue. There are a few common exclusions that we see across policies. One of those is an exclusion related to known issues. This type of exclusion is common, not just in reps and warranties, insurance, but really across the full range of insurance coverage. It excludes coverage for losses attributable to issues that the parties were aware of at the time of placing coverage under the general theory that you, you just, you cannot purchase insurance for existing or known loss. A second, common exclusion is purchase price adjustments. Often the asset purchase agreement allows for a post closing purchase price adjustment based on financial metrics calculated as of that closing date. And so reps and warranties policies generally exclude losses deemed attributable to the that adjustment mechanism. Another one is uninsurable, criminal fines and penalties. This is also a common exclusion, not just in reps and warranties, but across policies of all types and in many cases tracks state law providing that such fines and penalties simply are not insurable. The rationale here is that such fines are attributable to willful or intentional and therefore uninsurable activities or emissions. And then there are just traditionally a few itemized coverage carve outs. Two common ones, for example, are asbestos and underfunded pension liability rationale here with, with these carve outs as well as others. Is that other types of insurance are intended to be responsive to claims of this nature. So with that background and overview, I'd like to turn it over to Jeff to talk a bit more about his perspective as a broker in the reps and warranties insurance market. But first a little bit more about Jeff. Jeff Buzen is a partner in McGill and Partners mergers and acquisitions group where he focuses on structuring marketing, negotiation, and broking representations and warranties insurance, as well as tax liability insurance and other bespoke contingent liability insurance solutions. Jeff works on transactions spanning the entire mergers and acquisitions market. However, he has extensive experience in the financial services, food and beverage and life sciences sector. So Jeff, thank you again for joining us today.
Jeff: Thanks Dave.
David: And so we're recording this right about at the end of 2023. So I'd first be interested in your thoughts. Looking back on this past year. Have you seen any noteworthy trends or items of interest this past year or even further down the road that, that has impacted the placement or negotiation of these policies or, or really anything else?
David: Yeah, definitely. And I think you provided a great overview of reps and warranties insurance and what it is, but a little bit about the history of the industry, right? It it really insurance solution started taking off a little less than a decade ago. Um And then, you know, into 2021 and 2022 you know, the kind of busiest times of of the M&A market in recent history actually of all time, right, utilization of reps and warranties insurance was very, very, very hot. Ok? And the utilization rate of reps And warranties insurance across M&A transactions continues to be high and perhaps even higher this year than it was in in recent years. But the M&A market itself is much slower than it was certainly in 2021 and into the first half of 2022. And so what that means is there are more insurers, more underwriters in the market, but because there are fewer deals getting done, there's this mismatch between the demand for reps and warranties insurance and the supply side, right, the insurance capacity available to underwrite transactions. And so that means it's a, it's a very insured favorable market at the moment. Pricing retention have come down a lot. There are a lot of new coverage enhancements that insurers are offering that weren't readily available even a couple of years ago. And so overall, I'd say it's been a good time, a good year to be a buyer of reps and warranties insurance for, for all of these factors.
David: Thank you. That's, that's an interesting outlook. And, and so, you know, at this time of the year, a lot of clients are looking towards their deal activity for 2024. I'm sure the insurance market is also looking into what the next year in the, in the coming years might bring. Uh, do you expect any of these trends to continue into 2024 or what are, what are you seeing, uh, from a market perspective that might be the same might change or, or really just might be interesting?
Jeff: Yeah, I mean, ultimately, my view is we're going to continue to have been an insured, favorable market so long as the M&A market remains at the current activity levels and or until insurers start to start to leave the reps and warranties market, whether that's because of claims or just because they feel they aren't making sufficient premium to justify being in the business. And so, you know, we closely, you know, obviously monitor M&A activity broadly. And I think, you know, I don't, I don't have a crystal ball, but there are some positive signs in recent weeks that suggest that 2024 should be a busier M and a year than 2023 certainly with inflation numbers coming down and the fed indicating that there could be, there should be rate cuts coming soon. Um So, you know, from that perspective, I think there will be more reps and warranties, uh demand for reps and warranties insurance next year. As it relates to the insurer side, you know, a lot of insurance and reinsurance renewals are ongoing as we speak. And so we're in close communication with our insurance carrier partners to make sure, you know, we want to hear how those renewal meetings are going and making sure they really are committed and going to be able to continue to provide reps and warranties insurance capacity for the long term. Because ultimately, when there, if and when there is a claim for our insured clients, we want to make sure, you know, it's a insurer that's still in the industry and is going to have the motivation to act commercially in a claim scenario and handle that, that claim in a, in a good way that won't harm their reputation in the market. And so, you know, so far early indications are, you know that these reinsurance renewals are going in some ways better than expected, right? And so some insurer insurance carriers are actually going to have more, a higher limit, more capacity in 2024 than in 2023 which is surprising to some because we are in this kind of depressed rate environment at the moment. But I think it's, it's a good sign that insurance carriers and reinsurance carriers are committed to this space for the long term.
David: Thank you, Jeff, I appreciate your insight. And so with that, I think we should transition a bit to talk about reps and warranty's claims. And for that, I'd like to turn it over to my colleague Lauren Gubricky. As mentioned, Lauren is an associate in Reed Smith's insurance recovery group. She works on insurance coverage disputes for corporate policyholders of all types and industries. Many of are an increasing number of which are related to representations and warranties insurance issues and disputes. Lauren, thank you again for being here.
Lauren: Thanks, Dave. Happy to be here and happy to talk about the claims process and best practices, at least from the policyholder perspective. So, you know, Jeff touched on this already, but when a buyer asserts that a seller has breached a representation or warranty or at least has breached multiple reps and warranties, these breaches can have a serious financial impact on the company. And we've seen this impact be upwards of tens or hundreds of millions of dollars and the claim process is really where it all gets sorted out. So in the past few years, I've been able to handle a number of these claims and in our world, they range from, you know, relatively small amounts around $50,000 or so to many millions of dollars and regardless of the amount that's in dispute for these claims, there are certain procedures and best practices that policyholders should remember as they go through this process. So some of these, we all are probably familiar with just from claims handling under more traditional lines of insurance. Um And some of these are a little bit more unique to reps and warranties claims. So what is not unique to reps and warranties claims but is especially important for these types of claims is that the policyholder really needs to conduct a robust factual investigation before submitting anything to the insurance company. So typically after closing, the buyer discovers um a particular issue that really should have been disclosed prior to closing. Um obviously, that's not a great situation to be in. But the good part is that now that the deal has closed, the buyer now has access to the information and people and can really just start conducting an investigation from the beginning and see the buyer might know that there's a problem and think that the reps and warranties policy will cover them. But without knowing the specific details of the breach and the loss, the buyer can't really know like which representations or warranties were actually breached. So this is really the time that the buyer is to determine, you know, what is the loss or at least, do you have a reasonable estimate of the loss? What caused the loss? Um Does the loss involve negligence or does it rise to the level of fraud? And importantly, what was known about the loss prior to closing and who knew about it? Reps and warranties policies are usually pretty specific as to whose knowledge triggers a breach. And the policy and the purchase agreement will usually identify certain people by name or at least identify people like by title. Um And so this whole factual investigation process is the most time intensive part of the claim and many times, you know, the the deal has closed, people are moving on, you're running with the business making good money, but then uh we have to deal with the threats of warranties claim. But it is so important that everybody gets together and has all of the information that you can possibly get on the claim before submitting an actual claim to the insurance company. The next part of the claim process is really just at least from the policyholder side is really just taking a look at the transaction agreement itself and the policy with the purchase agreement like Jeff and Dave were talking about, you're really just looking at the specific representations and warranties. You know, Dave touched on a few of these, but most of them have typical reps and warranties like compliance with certain laws and compliance with taxes. Um but some transaction agreements may have industry uh specific representations and it's often the case that one breach or one loss will implicate multiple representations and warranties. With the policy itself, you're looking to see if any exclusions apply and also taking a look at the really practical things like limits the retention, things like that. And finally, once we've done this big investigation and we know what the policy says, we know what the purchase agreement says, you're ready to start drafting and submitting the claim. So most policies are really specific on what needs to be included in an actual claim. It typically requires a narrative of what has happened. An identification of specific representations and warranties that were breached, or potentially breached, or likely to be breached, and a reasonable estimate of the loss as you know it at the time of submitting the claim. And this is what kick start the claim process. Um The insurer has a set amount of time that they're required to at least respond to the claim. And like in other claims under more traditional lines of insurance, um they'll probably issue like a preliminary coverage letter broker is often involved in this process. Um And there's a further exchange of information and that's when the policyholder will start to see any coverage issues that might arise. And so, you know, I recently dealt with a pretty large representations and warranties claim just a couple months ago. What happened in this claim was that there was an undisclosed change in the law that severely affected the buyer's profits. And so one issue that the insurer raised was how this particular change in law affected our company individually versus other quote similarly situated companies. And that's sort of a term of art. And we had done this robust factual investigation like I mentioned, and so as soon as that coverage issue was raised by the insurer, we already had good information on these other, you know, similarly situated companies and were able to very quickly respond to the insurance company’s coverage issues and request for more information and ultimately successfully resolve the claim through mediation. So I won't continue to bore everybody with this claims process. But that's sort of an overview of how these reps and warranties claims happen and how a policyholder can best position themselves for coverage under the policy. So, Jeff, I know you talked a little bit earlier about some trends in the market with respect to your placement and pricing and so on, but transitioning to claims a little bit, are there any claims activity that you think is having sort of an outsized impact on the market right now?
Jeff: Yeah, I think so, Lauren, I mean, when you look at most claim studies that are out there and you know, our own data internally at McGill and Partners, you know, it's, it's pretty consistent that about one in five policies will have claim notices submitted on them. Um But the the vast majority of those fall within the retention or are precautionary in nature. Um But so really, it's 5 to 7% of policies, give or take, have an actual loss paid out on it for the insurers come out of pocket, paying the insured for loss that's in excess of their retention or deductible under the policy. And that's, that's been pretty consistent year over year. But what's interesting is that since, as I mentioned earlier, 2021 was the busiest year on record for reps and warranties insurance that means right now in 2023 and 2022 insurers are getting more claims and claim notices than ever before because there's a kind of natural 6 to 18 month lag between when a deal closes and when a breach is actually discovered and submitted to the insurance carrier. And so insurers are getting more claim notices and more data on claims than they've ever gotten before as a result of that. And there are a lot of, I think interesting takeaways from all, all of these new claims that are coming up. And it's definitely impacting how insurers are approaching underwriting on the front end, right, when they're actually placing policies today. So, I mean, in particular, you know, where one area where we tend to see the most severe claims are whenever it's a claim that is impacting how the buyer valued the business at closing. Right. And so whether that's based on a theory of multiply damages or diminution in value, those tend to be the most severe claims. And importantly, insurers in the industry are paying out claims on that basis and recognizing for certain types of breaches that is the appropriate measure of damages. And let's say you have a, a $1 million issue, but you paid 15 times a multiple of EBITDA to value the business and this is a recurring $1 million impact on the business that's going to impair earnings, uh, in perpetuity, then the appropriate measure of damages might be $15 million instead of that $1 million. And so oftentimes these types of these breaches might relate to financial statements reps, but it also could relate to other types of reps as well such as material contracts. And so insurers are very focused on the due diligence that buyers are conducting. Not only on the the financial statements, that's kind of been the case for years and years and that will continue, but especially on those key customer and key supplier relationships. They want, they want kind of independent um diligence and verification that those relationships are strong and aren't going to go away post closing, that's going to result in some large loss, post closing. Uh Another area that's kind of emerging where we've see seeing more and more claims and particularly more and more severe claims relates to condition of assets and uh on condition of assets. There's actually a $1 billion, that's with a B, rep and warranty claim that's percolating in the market at the moment and for based on that claim alone, but also, you know, other claims and in relating to breaches of the condition of assets rep, you know, that's a rep that says that the physical assets of the target company are in good working condition, subject to ordinary wear and tear, right? And so now, insurers for asset intensive target companies are increasingly focused on um buyers conducting technical due diligence, reviewing maintenance logs, really you know, getting under the hood, so to speak and getting comfortable in getting the insurers therefore comfortable that, um, you know, there are the physical assets of the target are in good working condition and that, you know, you're not going to have some, some big surprise post closing when the buyer actually takes control of the business and turns out actually now all these, all this machinery, all this equipment needs to be completely overhauled because it isn't functioning properly. So, yes, there are lots of, lots of claims, many have been resolved successfully, many are ongoing and it's definitely having a big impact on, on how underwriting is, is being conducted. Um But ultimately, I think, you know, it's, it's for the best, right? We want we as the broker, right, we want to be in a position where we can advise our clients to make sure that they're scoping the due diligence in a, you know, what a customary buyer would do or a commercially reasonable buyer would do such that they can get coverage for all of these broad but really important reps and warranties that they're negotiating into their transaction agreements.
David: Thank you, Jeff, again, very insightful and appreciate your advice and, and insight into the claims process that concludes our conversation today about all things, reps and warranties, insurance. Again, I'm David Cummings and I'd like to once more thank Lauren and Jeff for their time and insight today. This has been Insured Success. Thanks very much for listening and we hope you tune in again for our future episodes.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcasts, PodBean and reedsmith.com. To learn more about Reed Smith's insurance recovery group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
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Laura-May Scott and Margaret Campbell analyze the ABN AMRO Bank N.V. v. RSA et al case in detail and also cover what should be included in a marine cargo policy.
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Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Margaret: Hello, welcome back to the Insured Success IRG podcast. I'm Margaret Campbell, a partner at Reed Smith and this is my partner, Laura-May Scott. We are both insurance recovery specialists. Today we're going to present to you a case analysis on a very important case that we worked on during the pandemic. In this case, we represented ABN AMRO who was suing a group of 14 insurers in the company and the Lloyds Market and ABN’s broker, Edge, for losses it thought it should have been covered for under its marine cargo insurance policy.
Laura-May: And it's worth setting the scene here a bit and reminding listeners what a marine cargo policy typically covers. A marine cargo policy does not just provide cover for marine transit. It's capable of being extended to cover transport by air, rail, road and storage. So marine cargo cover can ensure the entire movement irrespective of the means of transport of the underlying goods. Now, under a standard insurance policy, it's only the physical loss or damage to the goods which is generally the subject matter of the insurance.
Margaret: So going back to the ABN case, the case there concerned losses of £35 million suffered by the bank when two of its customers Transmar and Euromar defaulted under a series of repo financing deals over cocoa and cocoa products. And a significant fraud was uncovered in relation to the defaulted transactions. Not only had the same goods been pledged to various banks, but the quality of the goods was absolutely terrible. Following their defaults, the bank was left holding large quantities of cocoa and cocoa products worth only a fraction of the loan repayments due to the bank. During the course of this case, Laura-May and I learned a lot about cocoa and cocoa products, much more than the man on the street ever knows. And we would issue a warning to everyone listening to this podcast to avoid cheap chocolate.
Laura-May: Yes, indeed. Initially, we worked with the bank and the broker to seek to persuade the insurers to actually pay out under the policy. We gave presentations to them on the underlying goods and the steps that were being taken by the bank to recoup losses. Thereafter, we entered into formal correspondence where the bank formally claimed an indemnity for the shortfall under an all risks policy of marine cargo insurance, which as Margaret says was placed with 14 cargo insurers in the London market by Edge brokers. However, the insurers formally rejected the claim after five long months of discussion.
Margaret: So this claim was actually made for financial losses arising from the defaulted transactions. The problem was the cargo was valued at 35 million and when it came to be sold, it was worth, you know, just a couple of million. Uh There had been no physical loss or doubt with just a question of quality. For those of you familiar with marine cargo insurance, there have been many legal authorities in England that say that in order to trigger a marine cargo policy, you must have physical loss or damage to the cargo. So what was different here? Well, in this case, this was precisely the risk that the bank was, was concerned about and they talked about it internally, they took legal advice from outside lawyers, they talked to their brokers, they went backwards and forwards for months saying in this scenario, what would happen in that scenario, what would happen? They wanted to make sure that their insurance would respond to them in the event that there were any problems. So this was the risk they were concerned about and they negotiated or thought they'd negotiated a bespoke clause in the policy which is called the Transaction Premium Clause. And this provided, the bank was covered for amounts that the insured would otherwise have received and or earned in the absence of a default by a customer. The bank and the broker contended that the effect of this clause was to add a form of credit risk or financial default insurance to the cargo policy. This had been written into the contract after, as I said, all the advice they've taken from everybody and they had instructed their brokers to negotiate it with the underwriters. The brokers had confirmed, they discussed it with the lead underwriter. And as far as the bank was concerned, they had this cover and no problem.
Laura-May: And it's worth noting there that the marine cargo policy in question had various add ons, didn't it? So it wasn't a standard marine cargo insurance policy. Uh It had add ons such as confiscation, expropriation, fraudulent bills of lading. So this was really a very bespoke policy that the client had created over a course of many years. And the crux of the dispute with the insurers really was that those various add-ons needed to still be tied to the underlying physical loss or damage. So the Transaction Premium Clause in and of itself did not provide stand alone credit risk type cover.
Margaret: So how the case unwound with the uh the losses have been suffered? The bank thinking they were covered, said to the brokers, can you please notify the insurers? Uh the brokers notified the insurers but without actually consulting the bank at all. They just notified a small claim and put a value of $50,000 on which was completely inadequate. The brokers also notified under the wrong clause of the policy and it turned out many months later that we discovered they were looking at the wrong version of the policy. Um So that was not particularly helpful in dealing with the insurers. However, uh to begin with, the insurers didn't take any points defending the claim. They just acknowledged the claim. They reserved their rights generally. And uh we invited them to meetings to discuss the claim and gave them presentations on what was involved. And at that point when they realized that it was not a $50,000 claim, but it was potentially a 35 million claim, they actually changed their position and formally declined the claim.
Laura-May: So in their defense insurers argued many different things. They argued primarily that the underwriters would never have agreed to underwrite credit risk. And that the clause in question was only concerned with the basis of valuation. So they were trying to link it to another valuation clause that did require physical loss or damage and their explanation exactly of how that basis evaluation clause linked with the transaction premium clause was never entirely clear. Um They also raised arguments around the ability of the marine insurers to actually write the credit risk. They said that they weren't entitled to do so under Lloyd's regulations. They argued that the policy had been induced by misrepresentation or non disclosure and they purported to avoid it by a late amendment to their defense.
Margaret: Basically, threw the kitchen sink at it and every single point they could raise, they did raise and they continued to change their position as they went along every time they thought of a different defense. Now, normally in the commercial court, which is the court we were in, in um, in London, it's a rule that prior to trial parties have to try and mediate the claim. And uh the reason for that is uh the courts take the view that it's not in anybody's interest to go through lengthy trials and costs and expense. And if a settlement could be reached, that's in everybody's interest. Our mediation in this case was unsuccessful and a large part as to why it was unsuccessful is that it was hybrid. Certain parties were present in the room with the mediator and other parties were on the screen and we were in the midst of the pandemic. So various people just were not prepared to come into London and attend the mediation. But I think this really brings home how important in any mediation it is to have people in the room. Only by being in the room, can they become properly part of the process and be persuaded to settle. Uh And by way of a side, you know, definition of a successful mediation is one where both parties go away feeling they haven't got a good deal. In this event, both parties, all parties went away and there was no deal. So there we were off to court.
Laura-May: And the case went to the commercial court as Margaret says, and we were still in the midst of a pandemic. And therefore, the trial had to be conducted on a hybrid basis, which was a logistical feat. when you think that we had over 20 factual witnesses, over eight expert witnesses and some days we were in the courtroom other days we were on the video. I mean, it really was quite an exciting new case to run in that the, this new way adapting to the circumstances of the pandemic.
Margaret: Yeah, I think it was one of the first commercial court cases to be run in that way. And in fact, on the first day, we were all, you know, in our own homes uh trying to do the case uh from there and we just found it didn't work because by the time you've emailed or messaged the barristers, the cases, you know, the points have moved on and all credit to the clerks to our barristers because we phoned up and said this isn't working. They arranged for a room which we sat in for five weeks with the barristers dealing with the case. Us down one end, we had a separate entry entry, uh all COVID rules and regulations were complied with that there, we were kind of not in court but kind of four screens and all all remote but able to communicate.
Laura-May: And then on to a lengthy judgment.
Margaret: All the witnesses gave their evidence remotely, but we were in court for the final submissions with the barristers, uh which included last minute applications by the insurers for adjournments and retrials. So that was all very dramatic. More evidence was sort of provided at the last moment. And uh they said that they wanted the opportunity to cross examine all the witnesses again on this new evidence. Anyhow, that was rejected by the judge and he proceeded to issue his judgment shortly after the six week trial, the bank was successful and uh they obtained full recourse from insurers and from the broker, Mr. Justice Jacobs accepted the banks submissions on the meaning and effect of the Transaction Premium Clause and he entirely rejected the insurer's attempts to avoid the policy. He agreed with the bank's argument that as a matter of construction, the Transaction Premium Clause provided cover for credit risk and or financial losses regardless of physical loss of or damage to the goods.
Laura-May: A great win for the client. The, you know, the Transaction Premium Clause that they had worked hard to create and put into the bespoke policy was carefully drafted. And the court found that the language was clear and they held that the bank's claims for the difference between the repo prices for the commodities and the amounts recovered by the bank through exercising its rights of sale were covered by the policy and due to be paid by the insurers and those sales were difficult. Those sales of the cargo when, when the bank was left holding the cocoa were difficult due to the underlying quality of the goods.
Margaret: I mean, some at the end of the day, just have to be sold for animal feed and some had to be scrapped. I mean, for example, some of the goods had already, we found out being treated for salmonella some years ago in Malaysia and we're now many years old, so not very attractive uh uh to buy on paper. Anyhow, the detailed judgment clarifies and elucidates many areas of law and is extremely helpful reading for insurance practitioners on the law of insurance in London. It covers many points, but I'll just pick out a few. First of all the interpretation of insurance contracts and the weight to be given to factual matrix considerations rather than just the words that were there in the policy. Secondly, the effect of a non avoidance clause in the policy of insurance and whether underwriters can circumvent such a provision by arguing that the clause itself should specifically have been disclosed when the policy was placed. And just as an aside on the non avoidance clause, I would say that if you have a negotiation in relation to your policy wording, if you can get a non avoidance clause in there, do try and get one because it really does help as Laura-May will explain later.
Laura-May: And the doctrine of affirmation, especially with regard to underwriters affirming a policy by pleading in a that was quite a key point raised in the judgment. The judgment also looked at the precise formulation and application of the test for inducement following a misrepresentation. Quite a large part of the judgment covers that.
Margaret: It also looked at the meaning of a reasonable endeavors obligation imposed on the insured during the currency of the risk and whether it can be breached by any conduct falling short of recklessness and it's quite difficult, quite difficult before that and to find uh actually evidence of what reasonable endeavors were, it was all very subjective in relation to, you know, every transaction. So it was, you know, very helpful, I think for any insurer to know that, you know, this can't be breached if you're not reckless. Finally, they looked at the duties of insurance brokers in detail and in particular, the nature and effect of the broker's duty to procure, cover that clearly and indisputably meets the insurance requirements and protects it against an unnecessary risk of litigation. Our expert witnesses were key in particular, our broking expert witness was marvelous and the judge was really impressed by him. Attempts by the other side to say that he was taking too rigid position were rejected by the judge.
Laura-May: So a full recovery for the bank mostly from the insurers and a little from the broker. This was an exciting case to be part of and a great result for the client. It's not the end of the chapter for certain of the other parties that are involved in the case.
Margaret: No, both the insurers and the brokers appealed against the decision. However, the insurers dropped their appeal against the bank after a day in court. The appeal continued solely between the insurers and the brokers. Case is now on appeal to the Supreme Court in relation to a dispute between the insurers and the broker on the question of estoppel. The appeal concerns the high court judge's finding that the bank was a stop by convention from relying upon the transaction premium clause against two of the 14 insurers. Mr. Justice Jacobs had rejected an avoidance case based upon a misrepresentation that the policy was as expiry, in part because the policy contained a non avoidance clause which prohibited avoidance save in a case of fraud. He nonetheless found that the as expiry misrepresentation created estoppel by convention because edge acquiesced in the underwriters assumption that the policy was as expiry. Consequently, edge was liable to the bank for the shares of those two insurers. Edge had appealed against this estoppel finding on the basis inter alia that the non avoidance clause not only prohibited avoidance, but also the rejection of a claim on the grounds of any non fraudulent misrepresentation. The court of appeal allowed the appeal on that basis. This will be a really interesting case when it comes to uh the Supreme Court as a question of estoppel is not being considered by the Supreme Court for many years. Originally, this was meant to be heard in July 2023 but it's been delayed by other more urgent cases which are going to the Supreme Court. We expect it to be heard early next year and we're certainly going to follow up on this in our next podcast and we'll explain the intricacies of that case further.
Laura-May: Great. Well, thanks for listening and we'll speak to you soon. In the meantime, don't forget to check out some of our other podcasts.
Outro: Insured success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean and reedsmith.com. To learn more about Reed Smith's insurance recovery group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and it is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
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Mark Pring, Catherine Lewis, and Tom Morgan break down the three pillars of ESG (Environmental, Social, and Governance), and discuss current risks that policyholders are facing and how they should go about mitigating certain risks.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Mark: Welcome back, everyone to our podcast series, Insured Success. My name is Mark Pring. I'm delighted to be joined by my insurance colleagues, Catherine Lewis and Tom Morgan to talk about some topical issues relating to ESG risks and how policyholders can try and mitigate such risks. I know you've both written quite a bit on ESG risks on our Policyholder Perspectives blog. Tom, starting with you and focusing first on the E in ESG what are some of the key risks facing Corporates at the moment?
Tom: Yeah, sure. So climate related litigation is the obvious one. So climate related disputes in the UK traditionally have focused on, you know, challenges to government decision making and policy through the judicial review mechanism. But I do think we're now seeing a change of approach focusing instead on corporate actors as, as the strategic target. I think this is in part because of increased transparency and disclosure requirements placed on corporate entities which produces more actual information and gives claimants greater scope to target claims based on, you know, embedded international standards and settled climate knowledge.
Mark: Ok. And what types of claims are we talking about here?
Tom: Yeah, it's a pretty wide array really. Challenges are coming from investors, consumers, activists, regulators and also litigation funders are increasingly looking to back some of these claims. Strategic climate change claims like the recent client Earth action, for example, targeting off directive notably failed to get off the ground, but it's unlikely to be the end of these types of claims in the UK. This exposure is arguably higher since the UK became the first G20 country to put into practice the goals of the task force on climate-related financial disclosures by making it mandatory for the UK's largest companies and financial institutions to report on their climate change risks. Activist claimants in the UK therefore often supported by institutional investors potentially have greater ability than in other jurisdictions to hold corporates to account. They can closely scrutinize disclosed metrics and net zero transition plans with reference to the impacts on agreed international standards.
Mark: Thanks Tom. So this, this seems to be a sort of information paradox, if I can call it that. On the one hand, you have inadequate disclosure of information which may give rise to corporate liability. Yet, publication of the same data may provide a foot in the door for strategic litigation against those same corporates.
Tom: Yes, exactly. So this risk is obviously at its highest for high emitting corporates. However, prospective claimants could target any sector, particularly those directly or indirectly financing carbon intensive companies, but also a wider array of industries including for example, financial services, retail, agriculture, and transport. Many of these you know, companies in these industries will also have set 2030 reduction targets and obviously 2050 beyond that. So we could start to see the claims rack up uh in the near future.
Mark: Understood. So what about the more traditional types of claim those seeking loss and damage?
Tom: Yeah, there haven't really been many breakthroughs in the English Court yet. However, outside of the UK, there has been a growing trend of claims seeking compensatory damages, the indirect impacts of climate change. One claim I'm following particularly closely has been brought by a Peruvian farmer against RWE in Germany. He said for the cost of constructing flood protection measures in his village in Peru which he claims that emissions released by RWE in Germany contributed to. The case is ongoing. But importantly, a uh a German court of appeal has already found that in principle, a polluter can be liable for the impact of climate change.
Catherine: And we should also note that loss and damage were also again a headline issue at cop 28 with the agreement to support developing countries suffering the impacts of climate change. And I think the acknowledgement that high emitters have a responsibility to compensate the damage caused to developing countries that are disproportionately impacted by climate change seems to align with this type of claim.
Mark: I completely agree. And um it's fair to say the English courts have always been a popular forum for international litigants assuming claimants can establish jurisdiction in the first instance. If the actions are successfully elsewhere, they may set a powerful incentive for more claims in the English courts.
Tom: Yes, completely agree. This may also be bolstered by the rapidly outstanding field of attribution science which by seeking to accurately measure the causative connection between climate change and individual environmental events will likely provide a further evidentiary basis for claimants against corporate actors. Furthermore, English courses are already dealing with complex group actions for loss and damage in relation to other environmental issues. And the overall trend is favorable towards complex actions involving questions of science attribution and quantum. So, you know, for example, last year, the court of appeal decided that the group action against BHP in relation to the Mariana dam collapse should continue despite its complexity and multijurisdictional nature. Surviving BHP's attempted strikeouts. You also have the vast Dieselgate claims going through the courts at the moment.
Mark: Yeah, I think we're we're all in agreement that class actions are likely to be a real growth area uh in terms of the types of claims that, that we're seeing in the near future around ESG. Insurers uh, will have to stay on top of, uh, what is a changing and, and growing risk profile for them. So, just shifting across and focusing now on the topical area of greenwashing, this is another risk area. If you like that we're starting to hear a lot about again with that wider access to company information and related disclosure requirements, as well as increased consumer pressure, companies appear to be at more risk than ever of greenwashing claims. Tom, did you have any thoughts?
Tom: Yeah, definitely. So, actions related to greenwashing in the UK typically require the claim to bring a claim for misrepresentation which requires reliance on misleading statements which can often be difficult to prove. However, increasing sustainability disclosure obligations for public companies as we've just discussed, offer an alternative route as claims for misstatement or publication of misleading disclosures can be brought against companies by investors.
Catherine: Absolutely right. I think it's also important to add here that whilst there have not been any notable greenwashing legal cases in the UK, regulators are wrapping up their focus on misleading and unsubstantiated claims made by companies about their environmental impact. So most recently, the CMA, the Competition and Markets Authority, has started an investigation into whether Unilever has overstated the sustainability of some of its products. And there will undoubtedly be more regulatory scrutiny of similar marketing endeavors by other companies who make climate related statements and advertisements. I'm sure you'll have seen adverts for certain international airlines have recently been banned for making misleading statements to consumers about those airlines environmental impact.
Mark: Absolutely, Catherine, we've all seen it. Just pausing here for a moment, we've been talking particularly about environmental risks and of course, this is an insurance podcast. So just for the moment, let's let's focus on uh the application of all of this to, to the insurance context. And obviously one means of mitigating the risk of direct corporate claims is through tailored insurance programs. But the sting in the tail is that the same growth in the risk of exposure to climate litigation has also resulted in increased demands for insurance coverage for such risks, then limited available capacity in terms of uh insurer appetite and also greater scrutiny from those insurers of placement and renewal of the risks. The result of all this being the further risk if you like of policy coverage disputes as and when uh a claim may arise. Catherine, do you, do you have any thoughts on this?
Catherine: Yeah. Um I completely agree with that and I think uh what we will see is that insurers will increasingly expect their insured to accurately disclose the risks that they face from climate change. And this seems to be particularly the case in light of climate litigation trends, which are expected to focus on the liability of Corporates to assess manage and disclose their vulnerability to a changing environment, changing economy and and changing customer expectations. And that is in addition to the traditional risk exposures.
Mark: I agree. And I think my personal view is that insurers are likely to focus on some key points. So first of all, the increased likelihood of insured claiming on liability policies as a consequence of claims relating to climate change. Secondly, management and governance claims in respect of climate change, where directors and officers could be held personally liable uh for failing to consider climate impacts in their decision making. And then finally, failure to properly measure and report company exposures to climate related risks as required by the TCFD that Tom mentioned earlier. For directors and officers, the new reporting obligations here in the UK and elsewhere could lead to personal accountability. So just moving on, we've talked about E, are we losing sight of uh the S and the G? Catherine, any thoughts on that?
Catherine: Absolutely right. So, whilst climate change and environmental issues are quite rightly very high on the agenda of all corporations as governments and individuals um take steps to mitigate the impact of climate change. I think it's really important that corporations don't lose sight of their obligations and consequent risks under what we call the social and governance elements of ESG.
Mark: Again, I completely agree. This is, this is obviously a rapidly developing area and insurers are gonna be under pressure to keep up with the range of judicial decisions and regulatory intervention in this context as well as the potential implications for coverage under their liability policies that they're writing. I think above all, we expect to see insurers probe policy holders at renewal in order to understand uh better uh their ESG related risks and liability policies, particularly directors. And officers liability policies even now we're seeing increased claims.
Catherine: I completely agree with that Mark. So shall we move on then to the, the S, social aspects? And this involves a corporation's interaction with its employees, customers and its stakeholders. And I think diversity and inclusion will continue to be a huge focus for various key stakeholders. In particular investors, customers and employees, businesses are ever increasingly being held to account by stakeholders to do more than simply pay lip service to DEI policies or risk litigation, regulatory action and reputational damage. I think in the same way that greenwashing is considered a litigation and regulatory risk companies may also increasingly find themselves at risk of social washing claims if they mislead about the positive social impact they claim to have. And so, for example, I think multinational sports brands have more recently come under fire in the media for making public statements to combat racism whilst facing reports of allegations of racial discrimination by their own employees. And I think it's only there for a matter of time before we start seeing the first of these so called social washing uh legal actions to to follow.
Tom: Yeah, sure if I can jump in there as well, I think another key theme in merging in the social limit of ESG is health and safety and working conditions. One of the key pillars of ESG related policies is transparency and that's not just the transparency of the business itself but also how it operates on the international stage. A number of claims have reached the English Courts in recent years. The UK Supreme Court, for example, found that a parent company could over duty uh get in respect of operations carried out uh by an overseas subsidiary, particularly in I'm thinking of the Vedanta case. And as I mentioned earlier, the Mariana Dam case relates to BHP subsidiary company which is also being sued in Brazil.
Catherine: These are really interesting developments, Tom and I think these cases demonstrate that the English courts at least are potentially willing to acknowledge the responsibility of an apparent company towards its workers in countries where its subsidiaries operate.
Mark: Yeah, and while it's easier said than done risk in this area can be mitigated by having clear policies in place as well as fostering a culture of transparency in order to allow for incidents such as those to be investigated and and managed appropriately. Policyholders in that context should also seek be able to seek, I should say to demonstrate to insurers that they have appropriate oversight of uh not just their domestic operations but but overseas operations as well. So conscious of time. Should we then focus on the G and ESG, governance, and Catherine, do you have any initial thoughts?
Catherine: Yeah, thanks, Mark. So this aspect encompasses a business's ethical and legal management, how a company governs itself. And this is a very broad topic and it's developing in many, many areas. And currently, um I think there's a clear focus on transparency and this ties into points we've been discussing already that customers and shareholders are rightly holding businesses to account. So in terms of a business’s leadership, in mid-2022 the FCA issued policy statement 22/3, which introduced changes to the UK listing rules and imposed a new comply or explain obligation to seek to improve the diversity of the board and executive management of listed companies. Great news. A key concern for businesses as a result of these comply or explain requirements will be the extent to which claims under section 98 of this, the Financial Services and Markets Act follow alleging for example, misleading disclosures in things like the annual reports produced. So a lot to think about and I don't think it's likely to be the end of de and I policies implemented by UK regulators. I'm sure we can expect both the FCA and the PRA to continue to focus on the diversity of businesses listed in the UK. And in addition to the makeup of a company's leadership, we are seeing increased scrutiny of supply change. It's no longer sufficient to ignore or profit from bad practices or illegal activity happening elsewhere around the globe. Um What do you think, Tom?
Tom: Yeah, I mean, I'd say that the key elements of this risk have actually existed for some time. So the modern slavery act requires companies to produce a slavery and human trafficking statement for each financial year. Assessing the modern slavery risk and supply chains in the business And looking at the bribery act, which also applies where an offensive an offense is committed overseas by a person connected with the UK. We have the EU's new deforestation regulation which came into force in June 2023 which requires companies to conduct extensive due diligence on their supply chains when dealing with certain products. I'm thinking, you know, cattle, cocoa, coffee, palm oil, soya, wood. So implementing robust policies, regular training and clear reporting lines will enable the risk to be monitored in incidents when they do arise to be managed appropriately.
Mark: That's all very practical and just thinking sweeping all of this up in terms of mitigating ESG associated risks. It's gonna appear daunting for many insured, but it is, I think possible to navigate the positive changes brought about by an increased ESG focus through implementing in particular as we've discussed already robust policies and procedures. Uh Insurers expect to be informed about a company's ESG awareness and related programs as well as the implementation of those programs and policies and indeed their monitoring. In particular I and others have noted that D&O underwriters have been eager to understand what disclosures and commitments insured have made to the public and whether there are any underlying claims relating to such disclosures. For example, whether the directors have made claims about the diversity of the company's board of directors or the company's climate change statistics. Catherine any, any sweep up thoughts here.
Catherine: Yeah, I have a few. And we've all been thinking about the steps that policyholder can be taking in this environment and I'll just run through a few that, that we've been talking about. So one of the things that um a policy holder can be doing is to implement clear sustainability and ESG frameworks that cut across all business stakeholders. So in this regard, they can also produce um environmental and social impact assessment and just as importantly as producing the original assessment, have processes in place to monitor and update any impact assessments so the risks remain relevant. A policyholder should also be starting to really ensure that controls and processes are in place internally to ensure early identification of specific threats facing the business. So specifically, for example, ensuring that the money laundering reporting officer, MLRO, and other reporting and compliance functions are connected to the areas of the business where risks might arise to ensure that there's prompt notification to the insurance and legal teams. In addition, it's helpful for all parts of the business to engage proactively with legal teams to stay abreast of rapidly changing legislative and regulatory frameworks. And we've discussed this in some detail already and it's no longer acceptable or even possible to turn a blind eye to what's happening overseas. It's also helpful for policyholders to start thinking about having dedicated ESG managers whose role it is to collect relevant data and monitor risk. Finally, from me, an organization should start putting into place clear plans for implementing targets, whether these are climate based targets or DE&I based. And these plans should have concrete steps that can be demonstrated to insurers and regulators.
Tom: Great, thanks Catherine. And just one more point from me, policyholders should really engage with insurers and or their brokers early ahead of a policy renewal. They should when doing so expect questions in proposal forms and in discussions with the insurers about what steps are actually being taken to mitigate the risks associated with ESG.
Mark: Great points at the end there from both of you. Thank you and thank you everyone for listening to Insured success. We absolutely look forward to joining you again for another episode. Bye bye.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
Transcript is auto-generated.
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In this episode, Ellie Ruiz and Kelly Knight discuss the ins and outs of non-payment insurance policies. They address the non-negotiables and other key issues that policyholders should be aware of when purchasing non-payment insurance.----more----
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Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's Insurance Recovery lawyers from around the globe. In this podcast series, we explore trends, issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected] We'll be happy to assist.
Ellie: Hello and welcome to the Insured Success podcast. My name's Ellie Ruiz and I'm a senior associate in the insurance recovery group at Reed Smith. Today for this episode, I'll be speaking with Kelly Knight from the Reed Smith Structured Finance team and discussing the ins the outs and the non-negotiables of non-payment insurance policies. We're aiming to refresh the key issues for clients you're aware of when they're purchasing non-payment cover. And then Kelly has very kindly rounded up some common queries she sees from clients including this type of cover to mitigate credit risk in financing transactions with a particular focus on receivables financing.
Kelly: Thanks, Ellie, you and I have worked together on a receivables financing which raised a number of questions about the nature and scope of non payment insurance. And I've had clients raise similar questions on other deals which include credit insurance as a former credit support. We both know how important the insurance cover can be to our clients as policy holders when putting together receivables, financing transactions. So I'm looking forward to going over the fundamentals with you and discussing what we should be looking out for. So I think the best place to start might be a quick overview of what non payment insurance is exactly and when clients might want to consider taking it out.
Ellie: Perfect. Ok, so starting from the beginning, non-payment insurance, also known as trade credit insurance, it's a form of credit protection that protects a client from a payment default by the other party in a deal i.e. when there's a failure to make a payment on a scheduled due date. So there's a really nice degree of simplicity to non-payment insurance in that all that you require is a simple failure to make a scheduled payment. And that reason for failure to make the payment can be either an inability to pay, for example, due to change of financial circumstances or it can be a deliberate refusal to pay due to a dispute between the parties. These kind of policies do have the ability to be tailored to the specifics of each transaction, given the complexities, the underlying deals that you would be working on or that we're talking about. So it's particularly advantageous to have that level of flexibility between insurer and insured?
Kelly: Ok. Understood. And when considering how to take out non-payment insurance for receivables financing, what are the advantages or disadvantages to structuring cover as either two separate policies held by each of the seller and the purchaser or alternatively taking a single policy with the seller and the purchaser both named as co insured.
Ellie: So they're both interesting options. The advantage of being co-insured on one single policy be that either party. So the purchaser or seller could make a claim and be indemnified under just one policy, albeit you have two separate contracts. The idea is that one policy can still reflect different interests of two parties. But then there's no need for two policies to be purchased covering the same risk, the interests and rights of the purchaser and seller remains separate, which is critical, but subject to policy wording, an insured would be able to recover under the policy even if the other co insured has breached any of its terms because it's only breaching its own contract with the insurer. On the other hand, the disadvantages to being co-insured. A. there's a single policy limit which can be eroded by a claim from either party which might not be so agreeable to both parties on the deal. And B. there's less clear delineation between which insured is covered in respect of which receivables at any one time. And as you and I both know, it's always the gray area where you end up having the disputes; either between the parties or with insurers. In addition, sometimes insurers might reject the idea of co-insuring a seller and a buyer in a deal of this nature on the basis that insurers then can't pursue a subrogate recovery against one insured for an insured loss suffered by the other insured. So if it is a loss that is being caused by either seller or purchaser, then the insurer can't make a subrogate recovery because logically, there's no purpose in bringing a subrogate claim when the insurer would be liable to indemnify the claim once it had to be met.
Kelly: Ok. Got that. Um Now, to complicate matters further in many of our receivables financing deals, a purchaser will be receiving funding from one or more investors who typically will want any claim under a credit insurance policy to be paid to them directly. In your experience. Can insurance coverage be structured to achieve this. For example, can an investor or a security agent acting on behalf of investors also be a co-insured?
Ellie: It certainly it's possible. This kind of arrangement is - it's a policy by policy decision. But if we're looking at it from a very high level, there is the option to either add as a co-insured or alternatively, you can name an investor or a security agent here potentially as a loss payee. So as we've just been discussing, there are some clear disadvantages to being co insured And in addition to those that I just mentioned, when you're talking about investors, it's also worth noting that by becoming an insured, those investors would then have disclosure and other obligations to the insurers which can be hard to satisfied given their proximity to the deal and how much information they would have. Alternatively, a loss payee is just identified as having first rights over any payment out that's made by insurers. So that would address your initial query regarding any claim being paid out directly to investors. It also voids the need for a separate contract between insurers and investors. However, a loss pay lacks the authority of an insured under a policy. So they can't, for example, make a claim under the policy and absent any express language, clear evidence of a separate agreement, they wouldn't be able to enforce directly any lost payment rights against the insurer. So in that situation, realistically, the relationship between the purchaser and the investors in terms of how they treat that insurance policy would probably still need to be governed by separate documentation between them which the insurer then isn't a party to.
Kelly: Ok. Sort of. So lots to think about there. So when clients are going to insurers to put together a non-payment policy for complex financing deals like the ones we we deal with in our structure, finance team, will they be expected to have a complete picture of the deal structure in place or or final documentation to share with the insurer?
Ellie: Not initially, I I mean, I've seen when we've worked together how many iterations some of these documents go through. And I think at the stage where we're just trying to talk to insurers and put a policy in place at the beginning, a client would just be having to complete a proposal form of some sort or other. So you're applying for the non-payment insurance and you're just aiming to give sufficient information to offer the policy. In that context, the transaction would need to be described in some level of detail in the proposal form. And then ultimately, it's usually closer to when the policy contract is about to sign. The insurers are likely to want to see final form or very near to final form documentation. It's probably a timing issue there and what gets signed first and who requires what? But in particular, the receivable sale and purchase agreement is something that insurers are likely to want to see and understand. There's also on top of that and a much more general nature, there is a duty of fair presentation in accordance with our 2015 Insurance Act, which an insured is obliged to comply with. And that includes providing information, ensuring material representations are correct and also that no material information is withheld or misstated. So on a higher level, that kind of covers not being able to hide anything or change anything at the last minute that the insurers weren't aware of.
Kelly: Oh, well, thanks Ellie. That's, that's been really helpful just thinking about sort of specifics. What would be the key date that clients should be aware of in a non-payment policy?
Ellie: Hm, um Go to the obvious one first, policy period sounds almost too obvious. There's a start date and an end date, but in particular, the policy end date should ideally be very closely tied to the underlying transactional documentation And those related definitions just want to be very clear. There's no gap between when the deal itself has come to an end and when the insurance itself stops providing cover. Secondly, there's often a lot of definitions surrounding due date, date of loss. Due date is usually that scheduled date for payment of the debt, which goes back to that original description of what exactly non-payment insurance is. And then there's likely to be a very specifically defined date of loss, which is closely linked to the due date. And this is all about just ensuring the insurer and insured are clear about when a loss has actually been suffered. And in addition to that, I think it's always worth looking at the waiting period, which is often found in policies like these, it’s generally a period following that date of loss before the insured loss is payable. This is one that can be negotiated between insurer and insured and potentially it can vary depending on the circumstances of the loss. For example, if the loss is as a result of insolvency or deliberate refusal to pay those might be different specific time periods.
Kelly: Ok. Thanks Ellie. A term that we often see bandied about is, is insured percentage. Uh So, you know, as, as you can imagine, our, our clients are quite keen to understand what would leave uninsured, what would be an uninsured percentage.
Ellie: Yeah, I can see they might have some concerns there. Um What it means is just this policy is gonna pay out a percentage of the outstanding debt, but it won't be paying out 100%. Usually we find that insured percentage is anywhere between 75 and 95%. Depends on what's been purchased. The reason for this is an insurer will want to ensure that the client retains significant skin in the game and that just ensures their commitment to the deal and they're not using the insurance like a like a parachute. “Oh, well, never mind. No payment. We've got insurance.”
Kelly: Ok. That, that's interesting. I know some of our clients when they take out a non payment insurance policy, they, they view it as almost like a silver bullet that's going to cover all non payment risk in their deals. Is this correct or are sort of non payments uh such as, I don't know, non payment by a customer as a result of a dispute that might not be covered under insurance policy?
Ellie: Well, in theory, it is probably possible to have a policy which covers all nonpayments, but I have never seen one. In reality, it's unlikely. The place you're looking in a policy for the answer to that kind of question is the exclusion section. And that tells you what losses or nonpayments aren't going to be covered. The common ones that we would almost expect to see are non payments that are caused by the policyholder themselves or a deliberate breach or default under deal, documentation, failure to comply with material laws or regulations. The policyholder becoming insolvent or the policyholder engaging in fraudulent or criminal behavior that's relevant to the deal. So take your, you know, traffic issues to one side. In the case of non-payment by a customer as a result of a dispute. The key point tonight is there can be payment out but if that dispute is ultimately resolved and it's resolved in favor of the policy holder after the insurer has paid the claim out, there's an overriding rule against double recovery. So the policyholder can't take the money from the insurer and from succeeding in the dispute. So the policy will generally provide that that money has then be paid directly back to the insurer.
Kelly: right, ok. So in in respect of the uninsured percentage, so our clients sort of risk exposure would a client be allowed to look to mitigate that credit risk through other forms of credit support, you know, for example, like parent guarantee or something similar?
Ellie: It, it would vary policy to policy, but it's definitely, you're absolutely right. It's something that our clients should be aware of and it's something to consider really carefully. It's not at all uncommon as you say that a policyholder client like this might be wanting to benefit from a contractual guarantee or an indemnity. Some insurers will require that any other insurance or indemnities or guarantees which might cover the same losses should be called upon first. So they'll just put themselves in a ranking and say your parent company, if they've still got money, they pay out first and we all pay when you don't have any other options. Alternatively, it might be a requirement that just any recovery is made under the other insurances or guarantees indemnities are applied first before the non-payment policy steps in. In particular, in relation to that uninsured percentage. You remember, as I mentioned before, insurers preference for the client to keep some skin in the game. The policy might require that this particular percentage remains completely uninsured and that no other insurance cover or guarantee can be taken out in respect of that amount that may or may not be the case. We're talking about a company very closely related to the policyholder, but they're not going to want it to free up that sense of risk and being a little bit cautious mitigating any potential risk.
Kelly: Ok. Well, that's, that's definitely something that, you know, we ought to be taking into consideration when when structuring the transaction. Um just, just kind of going back to our discussion earlier about whether insurers would be expecting to see complete documentation of the proposal form stage. What about amendments that are made to deal documents after the credit insurance policy has been taken out, will insurers want to see that or want some sort of input?
Ellie: It's a very valid point because of course, just given the complexity of those deals that we've been looking at, it's obviously it's not uncommon for some changes to be needed in respect of the underlying documentation in these transactions over the course of deals that might be in place for a year or two. However, for the insurers, it's all about being able to just understand and manage the risk. So clients should realistically expect to see what we call a material amendments clause in that policy requires that insurers are told about and potentially have to give prior written consent to any material amendments for the insurance cover to remain in place. The nuance then I think comes in what exactly is a material amendment and that's where we sort of focus our efforts. You pay close attention to that. For example, some scenarios, those amendments might be able to be made on the deal side, they can be made without the insured's agreement, let alone insurer consent. So if your insurers put in a requirement that they need to consent to this first, it's completely implausible and doesn't fit with how the deal documentation operates. So just making sure that what's in the deal documentation and what's in the insurance policy align is really important.
Kelly: Ok. That makes sense. So looking ahead if for example, there was a situation where a policyholder client thought that they might be entitled to cover under their non-payment policy. What should they be keeping in mind? Like for example, what are the key timing points that they ought to be aware of? And, and obligations would there be on, on the client once they, once they suspected that a non payment event has occurred?
Ellie: Right, this is, yeah, we get the good stuff once they, once we're actually starting to look at making a claim. So firstly, you want to check the policy wording again and identify first and foremost the notification provisions and the exact detail they contain this is because the obligation to notify often comes way before the obligation to make a claim. So that's at the stage where you, you mentioned the word “suspected” and it's at that stage, generally at which insurers have to have that flagged up to them. As a general rule, it's then advisable to liaise with brokers or insurers directly if that's how the policy has been set up and to do that promptly as well, just to make sure that everybody knows they've been told. And when they've been told. More generally, the policyholder client wants to be alive to any regular reporting obligations. Suspicions aside, the policy is likely to provide for obligations to ensure insurers are up to date about the deal's progress, scheduled payment dates that have been met thus far. And a part of this also involves maintaining good records of those communications and payments provides a clear trail for insurers to follow if we get to a claim scenario. The insured is often under an obligation to take reasonable steps to avert or minimize loss and wants to avoid any unreasonable steps that might increase the loss. On the other side of the coin sometimes costs like this. What we call mitigation costs will be covered under the policy. You just want to check the wording in each case. And then finally, a policy can specifically require an insured to cooperate with an insurer in the pursuit of what a subrogate claim. So this comes further down the line if a claim was paid out and the insurer takes on that role and the obligations on the policy holder can include protecting any rights which may or may not have been segregated and potentially specific requirements further down the line to assist in an actual recovery action depending on how far that goes in terms of providing access to individuals, documentation, records and so on.
Kelly: Oh, interesting. So you, you, you mentioned sort of subrogation which sort of brings me on to my next question for you. So if our client has, has made a claim and has received a payout under the insurance policy. If subsequently, the client manages to recover some of that claim from its from its customer, for example, or some other party, how should the client be treating those recoveries?
Ellie: It's worth going back here to that notion we were discussing earlier, this idea of an insured percentage and an uninsured percentage. I would expect overall a policy to explicitly deal with how recoveries are going to be applied. But generally, it's likely to be the case that first and foremost costs and expenses will be covered. And then after that recoveries would most likely be applied pro rata between the insured and the uninsured percentage. So, insurer and insured are recovering pro rata at about the same rate. Following payment of a claim, this is when an insurer has a right of subrogation that entices them to step into the shoes of the policy holder and they can exercise any of those policyholder rights or remedies against third parties. Again, this should generally be expressly set out in the policy and it can only take effect once the policyholder has been fully indemnified. As we flagged earlier one of the reasons that insurers might actually reject the idea of co-insuring a seller and a purchaser in a deal like this is because of that inability to pursue subrogated recovery against the seller if you're dealing with the purchase or the other way round for an insured loss, that's been suffered. Again it's purely logically what is the point in having a segregated claim where you're also the insurer on the other side having to meet that claim. So I think that's probably about all we've got time for today. It's a bit of a whistle stop tour through the key elements of non-payment trade credit insurance which can be complicated. Um But hopefully that gives a little bit more context to our finance clients or anyone looking to incorporate one of these policies into receivables financing. Kelly, is there anything else you wanted to add?
Kelly: Nothing for me- just to say, thank you very much.
Ellie: Brilliant. Thank you so much everyone for listening.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcast, Google Podcast, PodBean and reedsmith.com. To learn more about Reed Smith's insurance recovery group please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship, nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
Transcript is auto-generated.
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Business interruption (BI) ranked among the top concerns for companies globally in 2023. Extreme weather events, cyberattacks, fires and explosions, political violence, and COVID-19 will continue to drive BI claims in the coming year. In this episode, insurance recovery partners Mark Pring (London) and Anthony Crawford (New York) discuss BI insurance claims, examine recent case law on both sides of the Atlantic, and offer practical suggestions and insights for those considering whether to notify their insurer and/or to pursue a claim. They also outline tips on negotiating business interruption insurance policies.
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Transcript:
Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [email protected]. We'll be happy to assist.
Mark: Thank you everyone for joining us and welcome to Insured Success. My name is Mark Pring and I am a partner in Reed Smith's London office. I'm delighted to be joined by my partner Anthony Crawford from our New York office. We are both proud members of Reed Smith's top tier global insurance recovery practice. In today's podcast, we are focusing on the realm of business interruption or BI insurance claims. In the time allowed we cannot delve deeply into specific policy language, but instead, we will look at some recent case law on both sides of the Atlantic and offer some practical tips and insights for those considering whether to notify or pursue a claim as well as those in the throes of negotiating their BI insurance policy. Before we get fully started um, Anthony, what would you say is the accepted definition in broad terms of BI insurance cover?
Anthony: Hi Mark. So here in the US, we would generally say that business interruption or sometimes it is known as business income insurance, it's basically a form of property insurance covering losses of income suffered by a policyholder or business uh due to some type of loss or damage to his premises covered, that's caused by a covered cause of loss, which either causes some type of slowdown or suspension of its business operations.
Mark: That's great. And certainly that's exactly the kind of definition we would we would adopt over here. One thing we will explore is, is the idea of stand alone BI cover where you don't necessarily have to have prior physical loss or damage or any form of loss or damage to the premises. But we'll come on to that. So this topic is obviously very relevant given recent global events such as the war in Ukraine and again, uh the COVID-19 pandemic, I wanted to look first at some of the English case law that has emerged since the pandemic starting in 2020. And I think that the effect of COVID-19 on commercial operations has really transformed the way in which we look at BI insurance. Again, I'm sure on both sides of the Atlantic. Of course, some time has passed since the last lockdown here in the UK. But the rulings made by the English courts during the intervening period have undoubtedly continued to impact on the insurance markets approach to BI insurance generally. As everyone will be aware, COVID-19 led to a surge in BI claims as a result of forced business closures due broadly to lock down and other restrictive measures. At the start back in 2020 existing BI insurance cover to the extent it was bought separately from any physical damage or damage cover had not been negotiated with any clear understanding that something like a pandemic could even operate uh as a, as a real risk. As a consequence in the absence of existing court guidance, there was a lot of uncertainty about how these policies should be construed in the context of those lockdowns and other restrictions. Again, we've talked before about the expedited proceedings in what we call FCA and Arch and others up to the level of the Supreme Court. That was the first case in which the interpretation of BI policies in the context of the COVID-19 pandemic was properly explored. The case was brought as a test case by the FCA, the Financial Conduct Authority, as key regulator for the insurance industry. The FCA was concerned that so many of the BI claims notified as a result of losses stemming from the COVID-19 lockdowns were either being denied by insurers or subject to undue delays. Just to pause here for a moment Anthony, am I right that in the US, you've got no single regulator over the insurance sector and therefore no guarantee there'll be uh as here, pro consumer or pro small business?
Anthony: Yes Mark. That is absolutely correct. So in the United States insurance law tends to be a state law matter with a couple of exceptions for uh sort of maritime cases. Uh but uh therefore each individual state has its own regulator of insurance. Uh And so you will oftentimes can see varying degrees of the bodies of laws that are being developed depending upon the jurisdiction that you are in. Uh And there is absolutely no, unfortunately, no guarantee in either state uh that there would necessarily be pro consumer or a small business pro policy holder.
Mark: Yeah, that's a really helpful comparison. And I know that certain of our colleagues were very surprised when I told them what the FCA was doing in terms of intervening in the test case we're talking about.
Anthony: That would be an excellent policyholder benefit if there was some centralized government entity that was regulating insurance here. But unfortunately, or fortunately, depending on uh how you view it a long time ago, the call was made here in our laws to, to keep it something that is reserved for the States to rule on.
Mark: Got you. Well, back in the UK, the scope of the dispute in arch is, is hard to summarize given that the FCA had selected a significant number of test as it were policy wordings for consideration by the courts. But in broad terms, the key question was whether BI cover for certain perils such as notifiable diseases and prevention of access was actually applicable in the context of COVID-19. The outcome was largely positive for policyholders with the Supreme Court finding that subject to those policyholders establishing an appropriate loss, they could validly claim under the terms of at least most of their covers. The Supreme Court's judgment which was handed down uh back in January 2021 answered many but certainly not all of the core issues in dispute relating to the interpretation of common BI language unsurprisingly. However, lawyers on both sides of the insurance divide have continued to be creative since then. And I should at this stage mention a few key decisions over the last couple of years.
First in February 2022 the court in Corbin and King looked at a denial of access, non damage or fare's NDDA clause. Broadly, the clause provides cover where access to business premises has been restricted or hindered due to actions taken by a statutory body in response to using the language uh examining in Corbin and King, a danger or disturbance within a one mile radius. While in the FCA test case proceedings, it had generally been decided that so-called prevention of access clauses like the NDDA did not provide cover in the COVID-19 context. So that was one of the limited areas where policyholders were disappointed by the Supreme Court. In this instance, the divisional court, the High Court in Corbin and King found that insurers were liable to provide cover in circumstances where businesses were forced to close as a result of lockdown and other measures put in place to stem the spread of disease. So in this instance, COVID-19 was found for the purposes of that policy language from which I quoted, it was found to be a danger uh within that language. And while the relevant clause only provided localized cover, remembering the one mile radius language, it could extend to a disease such as COVID-19 if there were actually cases within the agreed radius. In addition, adopting the Supreme Court's approach to what we refer to as causation in the FCA test case, Uh the judge in Corbin, Mrs. Justice Cockerill found prevention of access clauses and this particular one, the NDDA clause did provide cover for BI losses suffered as a result of the pandemic. Inevitably however, given the amounts involved, many insurers have sought to distinguish the Corbin policy language from their own and have effectively forced various policyholders. Many of them to pursue a further test case this time brought by Gatwick Investment Limited and others against Liberty Mutual and others which was heard last October, its outcome will hopefully resolve or at least reduce ongoing uncertainty for numerous policyholders.
Second in June 2023 Mr. Justice Jacobs handed down judgment on certain what we call preliminary issues in the so-called at the premises or ATP test case proceedings for which six separate claims had been accelerated. In this instance, the policyholders argued that the Supreme Court's finding on concurrent causation, which effectively was to the effect that each and every occurrence of COVID-19 in the country the UK was an equal effective and therefore proximate cause of the government action that led potentially to loss. The policyholder argued that that finding applied in the same way to so called at the premises clauses as it already did supported by the Supreme Court to the so called radius clauses. And we saw reference earlier to radius clauses. So if a single occurrence of COVID-19 within one mile of the insured premises was a proximate cause of government action and therefore business interruption, the same must be true. So the policyholder said for a single occurrence at the premises themselves, not just within the one mile radius, the court supported this while some insurers with the FCA's forceful encouragement drew the analogy between those Radius claims and the ATP claims, other insurers refused to meet those ATP claims. The June decision should in principle unlock a significant amount of cash. Although as I say, a number of insurers with permission are pursuing appeals. So those are the first two key areas uh in terms of further cases that are going through the courts. Finally, for today's purposes, there are the high profile Stone Gate and two related cases heard by Mr. Justice Butcher in mid 2022 and dealing with among other matters, what we refer to as the aggregation of losses. ie. how in practice should the courts identify losses that in this case and I quote, arise from, are attributable to or are in connection with a single occurrence. First of all, there has to be an agreement on what we mean by the single occurrence in each particular instance. So two of the three insured including Stonegate sought to argue that there were multiple occurrences in order that they could claim that the applicable sublimits under their policy for business interruption losses applied on a per premises basis. Their primary argument was that each infection was a separate occurrence and therefore there were separate occurrences for the purpose of the policy in the vicinity of each premises which allowed them then to claim multiple sublimit. If we want to look at the practicalities, Stonegate alone would if correct in their arguments have separate claims of up to £2.5 million in respect of each of its roughly 760 venues. That's £2.5 million times 760 or leave others to do the math. In fact, Stonegate settled its claims just before the court of appeal hearing. But the relevant insurers involved in all three of these cases primarily sought to argue that there was only one or if necessary, a small number of occurrences such that only a single 2.5 million limit in the Stonegate case or a small number of limits of liability would be payable.
The third insured Greggs, the well known bakers, which has now also settled its claims, primarily argued that each of the various government announcements or measures was a separate occurrence. The court rejected the policyholders arguments at first instance and by policyholders there, I mean, the main arguments pursued by Stonegate, in particular to some degree, the court supported Gregg's position. Many insurers relied upon the court's rejection of the argument that losses should only be aggregated if at all on a per premises basis. Uh The court was particularly mindful of the argument that any new government response to the pandemic would likely impact businesses in a unitary way across the country and from the insurer's perspective. Therefore, they took advantage of the idea that you should aggregate all losses that flowed from any particular government response. Perhaps more importantly than the position of the insurers. Their reinsurers have reinforced decisions that already taken to aggregate many covered claims. The appeals from Mr. Justice Butcher's findings in October 2022 even though reduced to various eateries by then uh were heard last November and much attention is focused on the outcome of that remaining appeal on aggregation issues given the very significant amounts at stake amongst policyholders generally. So these three decisions and their relevant appeals will offer some important guidance to all of us and our clients. The message more generally is that while some decisions that followed the Supreme Court judgment did bring a significant amount of clarity, there are still a number of key issues that are not fully resolved. The challenges and the appeals continue. So pausing there, Anthony uh and, and moving away from the UK, there may have been some similar issues but I think you, you, you've faced a somewhat different position in the states. What have you found to be to have been the impact of COVID-19 on the approach of the US courts to BI cover?
Anthony: Well, Mark, unfortunately, on this side of the pond, uh policyholders have not fared as well uh with their COVID related BI claims. So it's important to note a couple of uh nuances with the US court system as I mentioned before. Uh Generally insurance law is a state law matter. Now, federal courts in the United States will also hear insurance cases provided that certain jurisdictional criteria are met. Uh However, when they are hearing these cases, federal courts generally have to apply the law of the state where they're located with and within uh with the certain certain exceptions. And what they will do is that they will look to, you know, any ruling from the, either the state's highest court or then moving down to state appellate courts, if the high court hasn't ruled on a particular issue. The problem here is that with the COVID cases, there was often little or no guidance in state law as to how to rule, uh given the unique nature of the COVID insurance claims that were coming in. And this led to a number of the federal courts having to sort of guess, uh as to how state courts would rule. And unfortunately, the vast majority of federal courts early on started to find that there was no coverage related to property damage. The COVID BI claims and property claims that were coming in. Now, arguably, you know, policyholders would say that the federal courts were ignoring certain procedural rules uh by outright dismissing cases rather than accepting as they should. The allegations in the complaint is true, uh which is a general interpretation and procedural way that you go about, uh looking at motions to dismiss, you know, it's become so much so that even in the recent cases that in litigations that policyholders were initiating, they would go far beyond what would be the normal requirements in their pleadings to include um scientific data to include, you know, evidence from experts, but to no avail the courts were uh and continue to dismiss these cases outright. In a parallel you started to see uh the cases work their way up through the state court systems as well with similar uh disappointing results. Uh in general, what you have found is that the cases have raised a couple of issues. So if number one can the presence of COVID cause uh physical loss or damage to property or was it the case that the various state government shutdown orders that were issued to address the pandemic, that they cause some type of physical loss, uh triggering coverage. Now, we have now had some time over the few last few years to see these state court decisions start to come in as well. And again, unfortunately, uh they have not gone, you know, the way that the policyholders would like them to go. There are still a few notable jurisdictions such as California and here in New York where I am that have cases pending before them and we should see decisions there soon. Now there are some successes that have been had by policyholders. Those are generally policyholders that have specialized policies where the coverage is either not contingent on some type of physical loss or damage or there are other policies that have certain coverage extensions, for example, uh communicable disease extensions. Policyholders have started to see some success with those and those have been moving forward. But the general lay of the land is that again, as I said before, it has not necessarily been that more favorable for the policy all this year.
Mark: Thanks Anthony. It's a depressing picture potentially for policyholders, but obviously very important to know. Now, if we're talking about someone who suffered losses back in 2020 2021 we wouldn't be worrying about or shouldn't be worrying about notification of claims, but obviously businesses can get interrupted, disrupted and so on for all sorts of reasons and continue to do so. So just maybe broadening the picture a little bit and to a degree with the, with the benefit of hindsight based on our experience of the pandemic, what advice would you be giving to a policyholder looking now to notify a claim under a BI policy? What practical considerations do you think they should make sure they get clear before you know before even getting embroiled in a dispute, how do they sort of do their housekeeping first?
Anthony: Ok. Very, very good question Mark. So in general, I would give policyholders the same advice pre-COVID as I would give them post-COVID because at the end of the day, they are presenting insurance claim. So things that I tell policyholder is give notice as soon as possible. So you don't run a file of notice procedures that any notice requirements that you will find in your policies. Uh You also wanna make sure that you're given broad notice to the carriers in your insurance program because what you don't want to do is you find yourself thinking that coverage may only exist in one type of policy. When in reality, you may have coverage that's available to you in under a variety of policies within your program. Other things that you should do is policyholders should always make sure that they're taking steps to mitigate any further losses. As a practical matter, policyholders need to organize a team both internally and working with whatever broker or insurance professional that they're going to be using in order to present and put together a comprehensive approach that will help with their claim presentation to help hopefully ensure success with the claim that they're bringing. You wanna make sure that you got all your relevant documentation. BI claims are notoriously document heavy and it is important that you need a team getting all that information together, organizing it, putting it together in a way that you can present, you know, the best claim that you have for it in order to make sure that it is paid. And I always, always, always recommend that policyholders should work with insurance professionals to make sure that they are presenting their claims in the best light to recover the damages that they suffer as well as understanding all of the coverages that are available. And uh you know, in general, because insurance claims, particularly large uh business interruption claims can be complicated and you wanna make sure that you have as much help as possible to ensure the success of your claim,
Mark: Anthony, many thanks for that incredibly helpful and it won't come as any surprise to know that, you know, that's exactly the sort of advice, I wouldn't have articulated it quite as well, but exactly the sort of advice we would be giving our clients over here. It crosses borders and certainly, you know, in terms of overall lessons learned and lessons that, you know, equally apply to where you may be negotiating new cover, not just making a claim under existing cover policy, language is key to the extent your insurers are open to negotiation in what are tough times. You're gonna want to look very carefully with the help of your insurance broker at the scope of any exclusions, whether the limits and the sublimit of cover available to you are sufficient for your purposes. That of course requires you to understand your business. Any prudent business should continue regularly to identify its risk profile and implement appropriate mitigating steps and insurance is just one of the ways in which you can do that. I will say in, in, in the UK, by way of sort of conclusion to some of the cases, we've talked about the sort of stand alone BI policies that were considered by the Supreme Court are no longer available and the insurance markets if they didn't before certainly take the view now that a pandemic represents if you like a fundamental societal risk that someone else, a government should underwrite rather than the markets themselves and they appear to have little or no appetite for non damage cover. Certainly uh in the pandemic or, or broader disease based contexts. So we're in a very, very different world now. Um Anthony, I mean, just finally, what are you seeing uh from the US perspective in terms of the scope of BI cover following the pandemic?
Anthony: Yeah so even though the insurance industry here in the States has been successful, uh largely in defeating a number of the large COVID claims they have moved as an industry to take steps to explicitly exclude coverage for sort of pandemic claims. There were always virus exclusions that could, that could have been used in policies and a lot of the policies we we found those there. Uh but they, you know, are taking steps to make that a little bit more explicit. But at the same time, uh they're also offering as the industry tends to do coverage extensions that policyholders can purchase. Uh that would actually provide some limited coverage in the future, going ahead for pandemic losses. But the thing I'll note that, you know, COVID was unique. Various steel broad business interruption coverage that remains available to policyholders and always will, just policyholders will have to be cognizant of what their policies say and what their policies are covering. But these recent losses with coverage over COVID claims should not in any way dissuade policyholders uh on the merits of maintaining this type of insurance coverage.
Mark: Yeah, completely agree. Those are, those are very wise words. So wrapping up, there's a lot more to explore here clearly and, and will no doubt be exploring BI insurance in future podcasts. So I look forward to returning. But in the meantime, listeners should be having conversations with their brokers and insurers well, before their renewal date, uh in order again to ensure that their policies actually meet their needs. So thank you to everyone for listening. Uh It's been a pleasure and do look us up on reedsmith.com and enjoy what will no doubt be a very exciting series in terms of Insured Success podcasts. Thank you very much again.
Outro: Insured success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group. Please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome, any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
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Insurance recovery partners Carolyn Rosenberg and Anthony Crawford delve into artificial intelligence, the risks associated with companies using AI in their business practices, and the different insurance products that may help mitigate those risks.
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Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends issues and topics of interest affecting commercial policy holders. If you have any questions about the topics discussed in this podcast, please contact our speakers at Insured Success at reedsmith.com. We'll be happy to assist.
Carolyn: Welcome to our inaugural 2024 Insured Success podcast. My name is Carolyn Rosenberg. I'm a partner in the insurance recovery group in our Chicago office and I'll be in conversation today with Anthony Crawford who is also a partner in our insurance recovery group out of New York. Our topic today is AI, artificial intelligence and insurance and you can't help but see word of that, Uh no pun intended, in social media, in a newspaper, Uh certainly the World Economic Forum, recent report indicated that AI powered misinformation is the world's biggest short term threat. There has been a recent 2023 expert study on progress in AI um out of Oxford University that uh created some concern that artificial intelligence could take jobs fifty years earlier than experts predicted. There's been the challenge of AI and the worldwide concerns as well as the promise of AI. The National Security Administration, the NSA, has enlisted AI to fight global hacks. The um there's been stories that AI is helping catch breast cancer earlier because of technology and that AI is being used by nonprofits to help find missing Children. So you've got both the, you know, the horror stories, the concerns the potential exposures. And then of course, on the upside, the promises of AI. Anthony, perhaps you can start us off by indicating, have there actually been any reported lawsuits regarding AI that give us a better handle on how these exposures are being translated into potential causes of action?
Anthony: Yes, Carolyn, thank you. Uh There are, we are starting to see a number of different suits or administrative actions that are coming forth out of uh any of these use of artificial intelligence. One that comes to mind is a recent first with the Equal Employment Opportunity Commission uh having settled a lawsuit uh against an organization called iTutor Group Incorporated. And the basic gist of that was that they were, uh iTutor was using software, AI generated software, that automatically rejected older applicants in violation of the Age Discrimination and Employment Act. And so you can see that this is one of those uses of AI that ultimately cause an organization some liability. And one of the interesting things is that this is this organization had they used pencil and paper or just regular bodies and made the same mistake, they would also face that liability. But the twist here now is that they were using this software that caused that exposure.
Carolyn: Interesting. And have there been any defamation or IP related exposures as well in terms of any potential litigation that you've seen?
Anthony: So on the IP front, yes, there, there have been a number of concerns and you can see this generally in the media about the the use or of AI in this, particularly in the copyright realm and some of the implications there. You're seeing where organizations have to be cautious into making sure that their use of AI isn't violating those rights. And then the uh the other side, you're also seeing where there are complications where artists are actively using AI to help generate works and sort of the implicate the IP implications there as well as you know, other contractual implications where you know, if a particular artist is contracted to do something yet they use AI. Is it the artist doing that? Is the AI doing that? What are the implications there?
Carolyn: Yeah. And I know lawyers themselves are not immune. There have been some well publicized reports about one would call it hallucinations of AI that, that are reporting, you know, uh particular precedents of cases um in court briefs and then upon further examination, um, they don't turn out to be either accurate or in some cases even in existence. And that of course, is, is causing some consternation and concerns about the use of AI in legal research and in briefing. And you could certainly imagine that with respect to any misrepresentative or misinformation, particularly on financial reports that companies and reporting earnings or in reporting on developments could face some potential liability, breach of fiduciary duty. You know, in addition to the kinds of employment, defamation, consumer related IP related exposures that um, Anthony and I have talked about so, you know, but Anthony correct me if I'm wrong, I don't think we've yet seen any coverage, insurance coverage disputes with regard to AI. Is that your view as well?
Anthony: Yeah, Carolyn, I think that that is right. I think that we're seeing a lot of underlying claims that definitely have the potential to be something that would covered by insurance policies. But as of yet, we're not seeing any flood of coverage related litigation with regards to insurance for AI related incidents,
Carolyn: Right, and when we say, ok, there could be these exposures. Now, what do we do about it? And insurance is one potential tool for protection. You know, it, it, it doesn't appear that we need to sort of run out and buy an AI insurance policy. I think some of the ones we've seen on the market have been really more specific for AI companies. But if you're a, an organization or a corporation or a business or a fund that is not AI specific itself but is potentially using AI, what kinds of policies would you traditionally look at to see if there might be coverage for potential AI-related exposure?
Anthony: Carolyn, that's an excellent question. And, you know, I will note, of course, the insurance industry would love for policyholders to run out and buy completely new products. But the reality is uh a as with a lot of the things that we've discussed right now, absent some exclusion, these things should fall in to the traditional policies that already exist right now, such as your areas and emissions policy, your products, liability policies, your employment practices, liability policy. So for example, the EEOC claim that I gave you that at a basic and, and you break it down, it's still a basic age discrimination case, something that is traditionally covered by the employee practices, liability insurance policy. The only difference here is that this company used AI generated technology uh to violate the rights as opposed to using an actual person. You know, some of the other things you may see. For example, if a manufacturer is using an AI Suite to put out a product and there's something wrong with the algorithm and there's ultimately a defect with that product, it doesn't matter that AI was used or not, it's that there's a defect with the products and that will fall traditionally under the products liability type of policy. So the biggest takeaway from this is that entities and policy holders should, you know, not so much if faced with liability, not get so caught up in the AI aspect of it. But you know, the actual facts of the took the alleged violations and then look to their policies that they have in place for any available coverage.
Carolyn: That's very helpful because the, you know, traditional due diligence that one would do, and of course, we do a lot with our clients representing policyholders of reviewing the policies, making sure there's no exclusion, broadening definitions. And of course, being on the lookout if there are any quote AI enhancements that might come on the market, obviously you always want to keep vigilant in a rapidly developing uh field here, but there's no need for sort of immediate running out and, and looking at a policy if you have the traditional coverage that should um hopefully protect depending on the kinds of exposures um and causes of that may that may arise. But all that being said, we do know that AI is being utilized more in the underwriting in the insurance underwriting phase. And there have been some concerns about that from a state regulatory uh perspective. Anthony, what's your sense of what's going on there?
Anthony: Ok. So in essence, a number of states have recognized the potential pitfalls of using this technology in the underwriting process. And what they have done is to start to impose regulations that will safeguard consumers from sort of automatic pricing schemes used by AI that will take into factors that, you know, some not traditionally used in pricing out insurance policies such as social media feeds or uh you know, this uh a potential policyholders, social presence online. And so what these regulators are looking to do is to make sure that the insurance companies maintain, again, maintain and remain vigilant in their underwriting process. And you know, are accountable for any discriminatory practices that ultimately may come from the use of AI. Uh For example, some of the traditional things that we've seen in the past is using occupations or zip codes or education in pricing out insurance policies uh where states have regulators have pushed back on those practices. You're also seeing a rise in the use of AI in actual claims handling and concerns. There are that when you have this automated process looking at claims, uh there is the potential for the entities to get it wrong and unnecessarily deny claims. So you're seeing there's a couple of uh class actions that are out there against uh a couple of largest health insurers in the country regarding the use of AI in their claims handling in the, in the medical insurance field. And that's something that we'll keep monitoring here as you know, as part of our insurance recovery practice to keep a look out for things like that.
Carolyn: It would be interesting too in the same way that if you were to get into a coverage dispute with an insurer to ask the question whether the insurer and its claim handlers are using AI in reviewing claims and it might be a source of interesting discussion or discovery with respect to where that may lead um as among the tools that advocates may have for their clients in this situation.
Anthony: I agree, Carolyn. I think that you are going to see that question becoming a standard interrogatory or, and uh document requests in civil discovery. Uh That's, that's just, it's going to have to be asked and insurers are going to have to answer that question.
Carolyn: Yeah, it's, it's, it's clearly a a brave new world between the potential exposures that uh insurance coverages, but sort of one potential protection and certainly one to consider and be vigilant about uh because there are always enhancements to consider, there are reviews to be done to just make sure. And in the event that there is a coverage dispute to just be this vigilant on the use of AI in both what's been done on the underwriting end and on the claims end, Anthony, any other dos and don'ts or ways in which to be vigilant as we wrap up this podcast from your perspective.
Anthony: So for policyholders, you know, it as with everything, we always advise, look, insurance comes way way later down the line. All right, what is your, your, you know, the starting point for entities should be sound policies and procedures. So if your organization is going to employ AI, the organization should have a firm understanding of how it's going to be employed, what are the risks that are involved with that employment, and how they are going to mitigate those risks on a practical aspect, before some potential claim comes up. Now, obviously, life happens and should an entity be faced with a claim related to AI, I would give them the advice that I would give them for most any other claim. Ok. Give notice early, get help from some type of insurance professional. Make sure you are organized, make sure you have documentation. Uh make sure you have good lines of communication both within your organization with your broker or whatever advocate that you're using as well as with the insurance company.
Carolyn: Yep and coordination is key. Um Knowing also about attorney-client privilege which you do have with your coverage lawyer you do not necessarily have with, you know, other other professionals. Just be vigilant and monitor. Keep up with us. Uh We will be doing more on AI and insurance in our Insured Success podcast along with other topics. We work collaboratively with our colleagues who are deeply involved in AI guidance monitoring guidelines and all other kinds of good stuff. But we thank you for listening today. Anthony, thank you for being in conversation and we look forward to our next chat with you. No pun intended. Take best care. Thank you.
Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [email protected].
Disclaimer: This podcast is provided for educational purposes. It does not constitute legal advice and is not intended to establish an attorney-client relationship nor is it intended to suggest or establish standards of care applicable to particular lawyers in any given situation. Prior results do not guarantee a similar outcome. Any views, opinions, or comments made by any external guest speaker are not to be attributed to Reed Smith LLP or its individual lawyers.
All rights reserved.
Transcript is auto-generated.
