Goldberg Segalla's Professional Liability Monthly - April 2011

Goldberg Segalla's Professional Liability Monthly - April 2011 subscribers may access the enhanced versions of the cases below. Non-subscribers may access the free, unenhanced versions on lexisONE, if available.

I.   Directors and Officers

(4th Cir. March 24, 2011) [ /LexisONE]

Court Deems Prior Knowledge Provision a Condition Precedent to Coverage

Defendant, Continental Casualty Company, issued a professional liability policy to plaintiff, Bryan Bros., Inc., to cover liabilities arising from Bryan Bros.' accounting services. The policy agreed to provide coverage provided that prior to the effective date of the policy none of "you" had any basis to believe that a claim may be asserted. The policy also included an exclusion precluding coverage for any fraudulent or criminal acts but also provided a savings clause reinstating coverage for individuals that were not personally aware of such acts.

In February 2009, Bryan Bros. discovered that one of its employees, the firm's account clerk, had stolen funds from eight clients beginning in 2002 with the last theft occurring in July 2008. The victims subsequently asserted claims against Bryan Bros. Bryan Bros., in turn, sought insurance coverage; however, the defendant denied coverage for the losses. Continental Casualty contended that the employee fit within the policy's definition of "you", because she committed the thefts as an employee performing professional services, and she had reason to believe as early as 2002, before the inception of the policy, that her acts might be the basis for a claim. Therefore, the terms of the coverage agreement were not satisfied and coverage was precluded. Essentially, Continental Casualty argued that the prior knowledge provision operated as a condition precedent to coverage, not an exclusion.

Bryan Bros. argued that the prior knowledge provision was an exclusion, and because the employee was the only person with prior knowledge, the innocent insureds' provision saved coverage for any other insured covered under the policy.

Upon review, the Fourth Circuit concluded that the plain language and structure of the policy established that the prior knowledge provision is a condition precedent to coverage. The court stated that the insurer agreed to cover Bryan Bros.' liability on claims made during the policy "provided that" no one covered under the policy had knowledge of a potential claim. Accordingly, Bryan Bros.' lack of prior knowledge is a condition of Continental Casualty's agreement to cover Bryan Bros.' liability from acts pre-dating the policy. Because the employee had prior knowledge, there was a failure to fulfill a condition upon which the insurer's obligation was dependent. In closing, the court upheld the denial of coverage.

Impact: This is an interesting decision in that generally prior knowledge cases concern the subjective versus objective standards as well as evidentiary questions as to exactly what the insureds knew at the time the policy was obtained. Here, the insurer successfully argued that the initial grant of coverage included a condition precedent as opposed to an exclusion. Having convinced the court that the condition precedent was not satisfied, there was simply no coverage for the underlying loss.


STAEHR, derivatively on behalf of MORGAN STANLEY v. MACK, et. al.
(S.D.N.Y. March 31, 2011) []

Failure to Make Pre-Suit Demand Fatal to Shareholder's Derivative Suit

Plaintiff brought a shareholder derivative action against several past and present directors and/or officers of Morgan Stanley to recover losses arising from company's exposure to the subprime securities market, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act as well as state law claims for breach of fiduciary duty, waste of corporate assets and unjust enrichment. Defendants moved to dismiss the complaint for failure to make a demand on Morgan Stanley's Board of Directors and failing to meet the pleading requirements of Federal Rules of Civil Procedure 23.1.

Essentially, plaintiff accused the defendants of three areas of misconduct. First, he alleged that defendants committed securities fraud and breached their fiduciary duties by failing to accurately disclose Morgan Stanley's exposure to the subprime mortgage market. Secondly, plaintiff alleged that defendants committed waste by authorizing the repurchase of Morgan Stanley stock at a time when they knew that the stock price was inflated due to the ultimate impact the subprime crisis would have on the stock price in the future. Finally, plaintiff accused certain of Morgan Stanley's directors and officers of insider trading, alleging that they sold their personally held Morgan Stanley stock for considerably more than it was worth when they had access to certain non-public information concerning the company's subprime exposure. As Morgan Stanley is organized under Delaware law, the court was required to apply Delaware substantive law to decide the motion to dismiss. Under Delaware law, the requirement that a demand to the board of directors be made is excused if the plaintiff pleads with particularity the reasons why such a demand would be futile.

With respect to the claims that the Board acted improperly in authorizing the repurchase of the company's stock, the court determined that application of the test set forth in Aronson v. Lewis, 473 A.2d 805 (Del. 1984) was appropriate. As to the other two species of claims, the court applied the test set forth in Rales v. Blasdand, 634 A.2d 927, since plaintiff did not plead facts concerning any specific decision of the Board of Directors as would implicate the Aronson test.

As to plaintiff's claim that defendants breached their fiduciary duties by failing to accurately disclose the company's subprime exposure, the court found that the plaintiff had failed to specifically plead facts demonstrating why the challenged statements were false, and as such, could not show that a majority of directors faced liability either under the securities law or based upon a breach of fiduciary liability.

Similarly, with respect to the alleged wrongdoing of the Board in authorizing the repurchase of company stock, the court held that plaintiff failed to specifically plead that any Director possessed knowledge of adverse non-public information that would have suggested that the price of Morgan Stanley's stock was inflated. For the same reasons, plaintiff could not establish that a majority of directors would face substantial liability for waste of corporate assets based upon the company stock repurchase. Finally, with respect plaintiff's allegations of insider trading, plaintiff's complaint pleaded facts concerning alleged nonpublic information regarding the company's financial outlook possessed by only three of the twelve directors. Thus, the plaintiff could not show that a majority of the Board was interested or under the influence of other interested directors as required to demonstrate demand futility.

Impact: Once again, we see the difficult burden imposed on a plaintiff who fails to make a pre-suit demand on a Board of Directors in establishing futility.


WOJTUNICK, Plaintiff/Judgment Creditor v. Kealy, et al., Defendants/Judgment Debtors and TIG INSURANCE COMPANY OF MICHIGAN, Garnishee
(D. AZ. March 31, 2011) [ ]

Issue of Fact Regarding Violation of Cooperation Clause

This declaratory judgment action arises out of a complex securities fraud action and subsequent declaratory judgment by defendant's primary D & O insurer, Carolina Casualty Insurance Co. Ultimately, it was determined on a motion for summary judgment that Carolina owed coverage to defendants in the underlying action, certain officers and directors of International FiberCom, Inc. ("IFC"). Factually, the underlying lawsuit concerned securities fraud claims emanating from plaintiff Wojtunick's sale of his closely-held corporation, Anacom Systems Corporation, to IFC. After Carolina was found to owe coverage, plaintiff, defendants and Carolina entered into a settlement agreement whereby Carolina would exhaust its limits of $2,500,000 in payment of defense fees and indemnity in the amount of $2,026,641, representing the remainder of its primary limits.

TIG issued a $2,500,000 excess D & O policy to IFC. The excess policy "follows form" to the Carolina policy. At issue in the instant declaratory judgment action are several dispositive motions, including TIG's motions for summary judgment regarding the applicability of the "insured versus insured" exclusion, the fraud exclusion, and breach of the cooperation clause.

With respect to the insured v. insured exclusion, TIG argued that the exclusion applied because Wojtunick had become President of the merged entity ("IFC-ANA") during part of the time period at issue. The court rejected this contention, noting that in order for the exclusion to apply, Wojtunick must have been duly elected or appointed by the board of directors. Although there was some indication that Wojtunick was appointed president as part of an employment agreement, the court held that TIG had failed to meet its burden of establishing the applicability of the exclusion as the record failed to include any corporate records or resolutions demonstrating that plaintiff was elected or appointed president by the Board of Directors.

A secondary basis for contending that insured v. insured exclusion applied related to an endorsement to the Carolina policy entitled "Employee Securities Coverage Endorsement", which amended the definition of an "insured" to include employees on a limited basis. TIG contended that the amendment extended to include the definition of insured for purposes of the insured v. insured exclusion. However, the court found that the language of the endorsement did not evince an intention to globally amend the definition or an "insured" nor did it contain any language suggesting that the amendment applied specifically to the insured v. insured exclusion. Thus, TIG's motion for summary judgment on the insured v. insured exclusion was denied.

The court next considered the applicability of the fraud exclusion. The exclusion at issue barred coverage for "any deliberate fraudulent act; provided, however, this exclusion shall not apply unless a judgment or other final adjudication adverse to any of the Insureds in such Claim shall establish that such Insureds committed such ... deliberate fraudulent act." TIG took the position that because the parties had entered into a stipulated judgment resolving the securities fraud action, this constituted a final adjudication for purposes of triggering the exclusion. The court rejected this contention, holding that the term "final adjudication" did not include settlements. Further, even if a settlement could be deemed a final adjudication, there was nothing in the settlement agreement that established that any Insured committed deliberate fraud.

TIG also argued that the settlement of the underlying action without its consent constituted a breach of the cooperation clause. In opposition, plaintiff argued that the Insureds were relieved of their obligations under the cooperation clause based upon TIG repeatedly reserving its rights, thus anticipatorily repudiating the contract. Ultimately, the court found that the issue of whether the cooperation clause had been breached could not be resolved on a motion for summary judgment.

Impact: This case highlights the danger of entering into a settlement or stipulated judgment without the express consent of all implicated insurers. Despite the denial of TIG's motions for summary judgment, there is still uncertainty as to whether TIG will owe coverage, and all parties will likely incur significant additional expense before this determination can be made.


II. Errors and Omissions

(E.D. Penn., March 28, 2011) []  

Plaintiffs Prohibited From Maintaining Professional Negligence Claim Against Insurance Broker

 In this case, Plaintiffs Richard and Jo Anne Hirsch brought claims against the insurance broker Defendants, the Schiff Benefits Group and its principal, Matthew Schiff, (collectively "SBG"). Plaintiffs claimed that the Defendants misled them so that they would create and invest in a premium-financed insurance trust. Plaintiffs purchased a premium financed life insurance policy on Mr. Hirsch's life and financed the premium payments through a lender. Plaintiffs executed a guaranty in favor of the lender pledging personal collateral. The Hirschs asserted that the Defendants assured them there would be a secondary market for the life insurance policy that would provide a market value exceeding any outstanding obligation to the lender. The Hirschs alleged that there was actually no secondary market for the policy and as a result they had to pay over $238,000 for the debt to the lender.

One of the claims the Hirschs brought against SBG was for professional negligence. Plaintiffs alleged that SBG as a licensed insurance broker was liable for professional negligence based on his assurances. The court found that Pennsylvania courts have only allowed professional negligence claims against certain licensed professionals not to include insurance brokers. The court noted that the Hirschs cited no authority "clearly establishing a plaintiff's ability to maintain a professional negligence claim against an insurance broker with whom a contract allegedly exists." The court dismissed the professional negligence claim (and all other claims) against SBG.

Impact: Licensed professionals are not always subject to professional liability simply because they are licensed. There must be authority establishing a cause of action against a licensed professional in order for professional negligence claims to pass legal muster.


(E.D. Pa. February 8, 2011) [

In Pari Delicto Defense In Accountant-Malpractice Cases After "Aherf"


The recent decision in Bechtle v. Master, Sidlow & Associates, PA, represents one of the first tests of Pennsylvania's new take on the in pari delicto doctrine in the context of accounting-malpractice cases. In the 2010 Supreme Court decision in Official Comm. of Unsecured Creditors of Allegheny Health Educ. and Research Fund. v. PriceWaterhouseCoopers, LLP., 989 A.2d 313, 333 (Pa. 2010) ("AHERF"), the High Court held it is entirely consistent with Pennsylvania agency law to impute to the corporation the wrongful acts of management or its agents in accountant-malpractice cases. Literally meaning "of equal fault," in pari delicto may act to relieve a defendant of liability where the plaintiff was an active participant in the wrongful conduct for which it seeks redress. In AHERF the Court warned that it is only those accountants who acted in good faith, as opposed to those that participated in management's fraud who will be able to benefit from the in pari delicto doctrine.

In Bechtle v. Master, Sidlow & Assocs., P.A. a court appointed receiver filed a malpractice claim against the outside auditors of a defunct investment firm on behalf of various investors. Although the underlying investment firm operated a "ponzi scheme," the accounting firm issued clean audits of the investment firm's financial statements. The plaintiff alleged that the CPA firm's failure to detect the so-called "ponzi scheme" constituted professional negligence.

In defense of the plaintiff's claims, the accounting firm filed a Rule 12(b)(6) motion to dismiss the Complaint on the grounds that all of the plaintiff's claims were barred by the doctrine of in pari delicto. While recognizing the continued viability of the in pari delicto defense in the context of auditor malpractice cases under Pennsylvania law, the court denied the motion to dismiss largely on the grounds that the issue implicates a fact sensitive inquiry which, in the absence of discovery, was not ripe for disposition at the pleadings stage.

Impact: The Bechtle decision provides some of the first insight into how a federal court applying Pennsylvania law will evaluate dispositive motions based on the defense of in pari delicto in auditor malpractice matters. The court exhibited an apprehension to dismiss the plaintiff's claims without the benefit of discovery. The defendant, of course, may raise the in pari delicto defense as part of motion for summary judgment at the close of discovery if warranted.


III. Legal Malpractice


(D. Conn., March 17, 2011) []

Attorney-Client Privilege is Impliedly Waived in Claims of Ineffective Assistance of Counsel

 In Giordano v. United States of America, the Government filed a motion to permit it to interview Giordano's former criminal defense counsel and to review a copy of relevant documents. Giordano, the former mayor of Waterbury, Connecticut, was found guilty in 2003 of conspiracy to defraud the United States and to use interstate facilities to transmit information about minors. He was sentenced to a total term of 444 months, and the Second Circuit confirmed his conviction but remanded the case for reconsideration of the sentence in light of the sentencing guidelines. On remand, the judge denied Giordano's request for resentencing. Having exhausted his direct appeals, Giordano sought an order from the court vacating, setting aside, or correcting his sentence and, among other claims, asserted a claim for ineffective assistance of counsel.

 The government, in response, sought to interview Giordano's former defense counsel. The Court granted the Government's motion with some limitations. The court discussed the attorney-client privilege doctrine and indicated that the Second Circuit has never had occasion to consider the issue raised. The court stated that it has little difficulty in concluding that when a prisoner asserts a claim of ineffective assistance of counsel by his former lawyer, there is an implicit waiver of the protection of the attorney-client privilege as to the aspects of the former attorney's representation to which the prisoner claims there was ineffective representation. The court stated that the doctrine of waiver by implication reflects the position that that attorney-client privilege was intended as a shield, not a sword, noting, however, that implied waivers are limited to only that confidential information that is needed to defend against the prisoner's specific claims. The court also stated that it is aware of no federal court requirement that a Government interview of a prisoner's former counsel be on-the-record, and held that it would not so order. The court determined that it will be largely up to the Government and Giordano's former attorney to determine whether the particular information has been waived.

 Impact: This case shows the importance of educating attorneys to contact their malpractice insurance carriers for guidance with respect to any request for documents from third parties in order to determine whether the information has been waived and under what circumstances such waived information should be turned over, by court supervised proceedings, such as depositions and hearings.


(9th Circuit, March 28, 2011) [ /LexisONE]

 Bankruptcy Exclusion Bars Coverage for Alleged Malpractice Claim

 Bickerstaff, Whatley, Ryan & Burkhalter, Inc. was insured under a professional liability policy issued by plaintiff Zurich. The policy included an exclusion that eliminated coverage for "claims or costs, charges, or expenses arising out of. . .the insolvency or bankruptcy of the insured or any other person, firm or organization."

The underlying action arose from the insolvency of Caduceus, a medical malpractice self-insurance fund. Caduceus' receiver initially sued Spear Safer ("receiver action"). The receiver action alleged that Spear Safer's unqualified opinions on Caduceus' financial statements, among other things, enabled Caduceus to continue to rewrite existing policies, write new insurance policies, and leverage its capital well in excess of that allowed under Florida law. Spear Safer then filed the underlying action against Bickerstaff seeking contribution and alleging that Bickerstaff's reserve reviews and rate level recommendations directly impacted and caused the insolvency of Caduceus.

Citing the bankruptcy exclusion, Zurich denied coverage for the claim. Zurich subsequently filed suit seeking a declaration of rights under the policy. Bickerstaff argued that the complaint in the receiver action alleged that Caduceus' insolvency occurred in 1993 before Bickerstaff was retained. Therefore, Bickerstaff characterized the underlying complaint as a standard malpractice action based on what it performed for an already insolvent client.

The court rejected this argument. The court held that even if Caduceus was insolvent in 1993, the exclusionary provision would still apply because the allegation is that Bickerstaff contributed to Caduceus' worsening financial condition.

While the court did note the broad duty to defend, it also concluded that none of the allegations in the complaint or extrinsic facts known to Zurich gave rise to any potential liability under the policy. The court stated that the complaints in the receiver and the underlying actions together alleging that Bickerstaff's conduct contributed to Caduceus' insolvency was within the terms of the policy exclusion.

Impact: The insolvency exclusion contained in professional liability policies is not often applied in the context of legal malpractice. Here, however, the court applied a very broad reading and held that the law firm's involvement in the insolvency of the client was sufficient to trigger the exclusion.


(E.D. Va. March 16, 2011) []

 Defendants Awarded Summary Judgment, No Duty To Advise Outside Of Scope of Representation Established by Contract

 On September 10, 2006, the plaintiff Oumar Toure was working as a mechanic in Virginia when he was assaulted by a co-worker. During the course of this incident, other employees locked the plaintiff in a room in order to separate him from his attacker. The plaintiff resumed his position with the company after the assault. However, after the incident, he sought to file a charge of discrimination against his employer with the Equal Employment Opportunity Commission ("EEOC"). On January 21, 2008, the plaintiff met with the defendant James Ubom at his Washington D.C. law firm.

The plaintiff told Mr. Ubom about the circumstances surrounding the assault and other racial slurs directed to him at work since 2006. The plaintiff expressed an interest in filing an EEOC claim. Mr. Ubom advised that the plaintiff's time to file an EEOC claim relating to the 2006 assault and other incidents that year had passed but that he would handle any potential future EEOC claims. Plaintiff returned to the defendants' office on April 9, 2008 and informed Mr. Ubom that he had been called a derogatory name at work and quit his job earlier in the week. Mr. Ubom agreed to represent the plaintiff. Thereafter, in July 2008, the plaintiff was presented with a retainer agreement which he executed. The agreement limited the defendants' representation to damages resulting from the April 2008 incident involving the derogatory name directed at the plaintiff.

Thereafter, in 2009, the plaintiff presumably learned from his personal attorney in Virginia (who by this time had apparently assumed handling the EEOC suit) that he may have had state law claims in assault, false imprisonment and negligent retention against his employer stemming from the 2006 assault but that the statute of limitations for these claims had expired. Plaintiff filed an action for legal malpractice against the defendants claiming that they had failed to advise him of these causes of action. The defendants later filed an unopposed motion for summary judgment.

The court held that the plaintiff had established no duty which would form the basis for a legal malpractice claim. It stated that the July 2008 retainer agreement expressly limited the defendants' representation to damages arising out of events which occurred in April 2008 regarding the derogatory term directed at the plaintiff. It in no way involved any aspect of the 2006 assault. Even though the plaintiff had disclosed details about the assault, the court highlighted that the defendants' duty was rooted in the terms of the retainer agreement with the plaintiff. The defendants therefore had no duty to advise the plaintiff of additional causes of action outside the scope of that agreement and particularly when the defendants did not practice law in Virginia (The defendants claimed that they had indeed told the plaintiff of his potential state law remedies which was deemed an undisputed fact due to the plaintiff's failure to respond to the motion. Ultimately, this point was inconsequential to the legal analysis regarding duty.). Thus, the plaintiff's claims of legal malpractice failed as a matter of law and the defendants' motion for summary judgment was granted.

Impact: This case shows the value of narrowly drafted engagement letter between an attorney and a client which establishes the parameters of the legal services which will be provided.

 IV. Medical Malpractice

(3rd Cir., March 28, 2011) [ / LexisONE]

Third Circuit Addresses Diversity Jurisdiction

 Plaintiff was a nurse and resident of the state of Florida. She was recruited by the defendant hospital to assist in an open heart surgery at a hospital located in the Virgin Islands. While working at the hospital, she detected a small nodule on her right ***. The defendant-physician performed a biopsy on the nodule, which revealed that Plaintiff had *** cancer.

After Plaintiff learned she had *** cancer, she travelled to Kentucky to consult with a surgeon about her diagnosis. Subsequently, a lumpectomy was scheduled, which was performed at the hospital in Kentucky. However, neither the specimen removed during the lumpectomy nor the post-surgical mammogram showed any evidence of *** cancer. Plaintiff then filed a medical malpractice suit in the Virgin Islands District Court against the hospital in the Virgin Islands in addition to the physicians that treated her there.

The defendants filed a motion to dismiss and argued the district court did not have diversity jurisdiction. The motion was granted on other grounds. On appeal, the Third Circuit noted that a State is not a citizen for purposes of diversity jurisdiction. However, the Court has recognized that a political subdivision of a state is a citizen for diversity purposes. This rule applies to territories such as the Virgin Islands.

The main issue on appeal was whether the hospital had "alter ego status" for purposes of diversity jurisdiction. To determine whether a suit against an entity is actually a suit against the state, the Court must consider: 1) the source of the money that would pay the judgment; 2) the status of the entity under state law; and 3) the degree of autonomy the entity has. Plaintiff argued the hospital was a separate entity from the government of the Virgin Islands and of course, the defendants argued the hospital was owned by the Virgin Islands and was not a "citizen."

The Third Circuit found one district court case which held that a hospital owned by the government of the Virgin Islands was not a citizen for purposes of diversity jurisdiction. However, that court did not determine whether any judgment against the hospital would be paid by the Virgin Island's government. Therefore, that case was not binding.

The Court remanded this case to evaluate the three factors referenced above to determine whether the hospital had "alter ego status."

Impact: To determine whether a suit against an entity is actually a suit against the state, the Court must consider: 1) the source of the money that would pay the judgment; 2) the status of the entity under state law; and 3) the degree of autonomy the entity has.


 V. Fidelity Insurance

(S.D. Fla. February 24, 2011) []  

Proper Pleading - Who is an Insured and Necessary Parties

 Plaintiffs filed a claim under a fidelity bond seeking to recover employee theft losses allegedly suffered by PFP Associates, PFP Associates LLP and PFP Associates, Inc. ("PFP Entities"). Defendant issued the bond to Willowbend Development LLC ("Willowbend"), the named insured, to cover losses caused by theft or forgery committed by Willowbend employees. Employee Arnold Mullen allegedly stole tens of millions of dollars from the plaintiffs while he was employed by both Willowbend and the PFP Entities. The Plaintiffs claim they paid substantial premiums to the Defendant but did not allege they were a named insured nor did they allege any facts regarding their relationship with Willowbend. The Defendant moved to dismiss for lack of standing; an additional request was made to compel joinder of a necessary party, Willowbend, to the reformation claim asserted by the Defendant.

The Defendant contended that the PFP Entities were not named insureds under the policy and the complaint asserted no allegations that the PFP Entities had any relationship to Willowbend. The Court agreed that the complaint contained insufficient allegations to establish the status of any one of the PFP Entities as an insured under the bond.

The Defendant also contended with respect to its reformation claim that Willowbend must be added to the complaint as a necessary party. The Defendant contended that it would not be able to obtain complete relief without joinder because Willowbend would not be bound by any decision in the case and the Defendant would be subjected to duplicative litigation over the same loss. The Defendant also contended that Willowbend's rights would be affected without Willowbend being given the opportunity to be heard in the litigation. The Court found that Willowbend was, indeed, a necessary party.

Impact: This decision is instructive to counsel for claimants and insurers. Named insureds must bring suits; an explanation of why and how they are named insureds may be necessary in certain situations. Further, all parties need to ensure that the all the necessary litigants are in the suit in order to properly have rights and obligations decided.

VI. News and Notes

BP Funds Used For Cars And IPads?

It has been reported that funds BP paid to municipalities along the Gulf Coast have been used for a bit of a spending spree buying items that have little to do with the actual clean up efforts. BP says it has paid state and local governments more than $754 million and has also reimbursed the federal government for another $694 million. However, some officials have spent funds on new SUV's, IPads and laptops.

To view the entire article, click here:

Lloyd's "Confident" It Can Handle Japan Claims

Lloyd's continues to contend it can handle the billions of dollars in claims arising out of the Japan earthquake disaster. Lloyd's has stated that its businesses have enough capital to withstand losses of up to $64 billion.

To view the entire article, click here:

Federal Insurance Obtains Dismissal of Bad Faith Claims

Abercrombie & Fitch v. Federal Ins. Co.

Abercrombie & Fitch filed suit against Federal seeking defense costs relating to underlying securities and shareholder suits pursuant to an executive protection policy. Federal contended that A&F breached the terms of the contract by negotiating with a separate insurer for its policy to be in excess of Federal's policy, thereby prejudicing Federal.

The trial court previously determined that Federal was required to provide coverage for the underlying claim resulting in Federal reimbursing $10 Million in defense costs. The Sixth Circuit affirmed this decision.

The remaining issue is was whether Federal acted in bad faith by denying coverage in the first instance. While plaintiff has won a determination of coverage, to the extent the court deemed that Federal acted in bad faith the insurer could be exposed to extra-contractual damages. Federal filed a motion for summary judgment seeking dismissal of the bad faith claim.

In this regard, Federal won. While the court acknowledged that it disagreed with Federal's interpretation of the policy, the court held that Federal's interpretation was not "unreasonable." Accordingly, Federal did not act in bad faith. This victory, however, was not complete as the court also held that plaintiff did present a viable breach of contract claim leaving open the possibility of pre-judgment interest.

For a copy of the decision, click here:

VII. Featured Article



 The majority of people in the United States would probably consider a safe deposit box rented from their local bank branch to be the safest place to store their family valuables. People would also likely consider the safe deposit box vault to be secure and the best deterrent against crime (like burglaries and arson), floods and fires. These people would be correct.....most of the time.

Over the last 12 years, there has been a rash of safe deposit burglaries that attacked numerous financial institutions in the greater New York City area. American and world-wide viewers witnessed the attack of the Pentagon and World Trade Center on September 11, 2001. Witnesses, however, amidst the horror and sadness of that fateful day, did not realize that over 1,000 rented safe deposit boxes were ravaged as well. Ordinary citizens' personal memories, safely stored in a safe deposit box vault at 5 World Trade Center, also fell victim to that terrorist attack. The world watched the tragedy of Hurricane Katrina as it ripped through the American Gulf Coast, leaving thousands of people homeless, business destroyed and families torn apart. Amid the tragedy of that great storm, thousands of people, who believed their most precious items were safely stored in safe deposit boxes, soon came to realize that not even the bank vaults could have withstood the wrath of that hurricane.

Traditionally, financial institutions in seeking coverage for safe deposit box vaults and insurers in providing coverage only had to concern themselves with events such as burglaries, minor flooding and possible fires. Unfortunately, in today's climate of terrorist alerts and the rise of natural disasters, the scope of the safe deposit box coverage has expanded.

 II. Relationship Between Financial Institution and Customer

Generally, the relationship between a bank and its safe deposit bank customer is not defined with certainty under statutory laws of individual states. Many state statutes expressly authorize banks or trust companies to engage in the business of renting safe deposit boxes.1 The relationship between a bank and its customer is contractual in nature.2

Some states have conflicting language in their statutes. For example, New York Banking Law ("BL") Article VIII -A "Safe Deposit Business" only makes reference that the relationship as between the customer and the bank as a lessor/lessee relationship. Indeed under BL §332, the bank is defined as the "lessor."3 However, New York Banking Law confers to every safe deposit company the power to receive upon deposit as "bailee for storage, personal property and papers of any kind."4 The statute allows banks to lease their safe deposit boxes under circumstances that create a "bailment" but does not limit the bank's ability to limit that bailment relationship.5

The legal qualification of the relationship between a bank and its safe deposit box customer has a direct impact on the standard of care that must be employed in safeguarding the contents stored in the vault. Traditionally, this contractual relationship established between the bank and the customer is referred to as either a "bailment" or a landlord/tenant relationship.

In many states, the relationship between a safe deposit box rental and a bank is a bailment.6 Hence, in a bailor/bailee relationship, since the Bank is not an insurer of a customer's property, it must merely exercise reasonable care in safeguarding the property.7 Failure to exercise reasonable care will constitute negligence and if the bailor can establish that the bank's negligence caused the bailor's property to be lost or damaged, the bank will be liable for all loss sustained.8 Simply, for a safe deposit box customer to establish a cause of action against the bank, the customer must prove that he/she deposited the property into a safe deposit box at the bank. If the bank cannot return the contents of a customer's box to them, the bank must demonstrate that the inability to do so was because of an intervening act; i.e., a burglary. The burden then shifts back to the customer to demonstrate that the bank's negligence was the cause of the intervening act.9 The inference of negligence may be overcome if uncontradicted evidence is presented.10

While the bailor/bailee relationship is a creature of contract,11 the contract can limit the bank's common-law obligations provided the limitations are not unconscionable, offensive to public policy or the product of fraud or undue influence.12 Courts have upheld the wording of safe deposit boxes as binding contracts.13 Parties can agree to define the bank's liability as ordinary diligence.14Therefore, the bank can limit its liability to the exercise of ordinary care. The burden will be on a customer to demonstrate the bank was grossly negligent to establish any liability.

Many states, however, define the relationship between a financial institution and the customer as a lessor/lessee relationship. 15 The duties of each party are governed by the terms of the lease. Generally, the lessor/lessee relationship is an ordinary, arms length commercial relationship, and, therefore, the lessor is held to the standard of care expressed in the lease agreement, which, in most cases, is the standard of ordinary care.  

 III. Legally Allowable Items in the Safe Deposit Box Contract

Generally, safe deposit box agreements define the types of items that may be stored in safe deposit boxes. Courts will not recognize losses for items that should not have been stored in the vault in the first place.16 Generally, the types of items stored in a safe deposit box are "jewelry, securities and valuable paper." Cash has been held not to be "valuable paper." The contract between the safe deposit box customer and the bank will govern as to what is allowable in the safe deposit box. New York courts, for example, have noted that if an item is expressly excluded by the contract, the bank will not be liable for destruction or theft of those items.17

 IV. The Financial Institution Bond

Generally, safe deposit box losses should be investigated as any other fidelity loss. Depending on the circumstances of each individual case, arguments can be made that the loss should fall under employee dishonesty, transit or safe deposit box coverage. Scenarios in which an employee is involved in the loss or contents were lost in "transit" or ordinary safe deposit box losses are not uncommon. Typically, comprehensive crime policies will provide for losses under (a) fidelity coverage; (b) in transit coverage; and (c) safe deposit box loss.

Typically, "fidelity coverage" will provide coverage to a financial institution for losses directly from one or more dishonest or fraudulent acts by an employee with the intent to cause the financial institution a loss or to obtain improper financial benefit for the employee. This policy language may be triggered where an employee is involved in the theft or burglary of a safe deposit box or the contents of a safe deposit box.

Comprehensive crime policies will also provide coverage for "in transit" losses; losses resulting from robbery, larceny, theft, misplacement or mysterious unexplainable disappearance of property as defined by the policy language while the property is being "transmitted." This coverage may be triggered when the bank considers the safe deposit box abandoned and engages in a drilling process or if it the vault is being moved and contents are being shipped to a different location.

Finally, these types of policies contain safe deposit box coverage which provides for coverage for losses because of damage, destruction or disappearance whether caused by the financial institution or not. The coverage usually is for any securities, bonds, certificates, jewelry or other property with intrinsic value. Intrinsic value means the true, inherent and essential value of an item.

 V. Possible Coverage Issues

 A key question for these types of losses is whether all expenses incurred will be covered under the safe deposit box coverage agreement. Typically the safe deposit box insurance grant provides coverage for all claims for physical loss or damage including all costs and expenses incurred. At first glance, it appears that all recovery costs associated with damage to safe deposit boxes is covered. These expenses include the costs of experts that perform an evaluation of the contents of safe deposit boxes. Financial institutions will argue that other expenses, such as security costs, vault recovery, construction, cleaning, storage and locksmith fees are also covered. These insureds will argue that these costs were incurred in the mitigation of the loss. Insurers can argue that those costs were sustained as a result of the financial institution's corporate obligation to its customers and are necessary costs regardless of insurance coverage. These are disagreements that should be discussed and mediated.

Another vital issue that arises is whether the safe deposit box loss falls under any other insurance program. Insurers should analyze the financial institution's professional liability policies, general liability policies and property policies.

Usually a financial institution's professional liability policy will provide coverage where an insured's liability is alleged to have arisen out of an error, omission or negligent act committed by an insured while performing services in a professional capacity.18 The policy is only intended to insure a member of a designated calling against liability arising out of mistakes inherent in the practice of the particular profession.19Safe deposit box services are professional services. An insurer should examine the professional liability's exclusions to ascertain whether additional coverage is available.

Generally, property policies will provide coverage for the business property of the financial institution and not the property of safe deposit box customers. These policies become relevant when safe deposit boxes have to be moved to another location. Key inquiries will be what triggered the moving of the safe deposit boxes to another location. 

 VI. Conclusion

 While the coverage issues associated with safe deposit box losses are usually not complex, the decisions on how to handle these types of losses must contemplate insurance coverage and business decisions of both the financial institution and the insurers. Generally, the ability of the financial institution and the insurers to work together

1 See, e.g., California Fin. Code § 757(a)
2 See, e.g., California Fin. Code § 757(b)
3 New York Banking Law §332
4 New York Banking Law §317
5 Id.
6 See Fla. Stat. ch. 655.93 (1992); Barclift v American Savings Bank, 577 N.Y.S.2d 573 (Civil Ct 1991); Goldman v Bank Leumi Trust Co. of N.Y., 543 F.Supp. 434 (S.D.N.Y. 1982); Cussen v. Southern California Sav. Bank, 65 P. 1099 (Cal. 1901); Paset v. Old Orchard Bank & Trust Co., 378 N.E.2d 1264, 1269 (Ill. App. Ct. 1978); In re Estate of Schmidt, 119 A.2d 786,
7 See 9 NY Jur 2d ¶100; See also Singer v. Scott & Davis Motor Express, 436 N.Y.S. 2d 508, 509 (App. Div. 1981).
8 See Sagendorph v First National Bank, 218 N.Y.S. 191 (App. Div. 1926).
9 See Sun Yau Ko v Lincoln Savings Bank, 473 N.Y.S.2d 397 (App. Div. 1984) affd 479 N.Y.S.2d 213 (1984).
10 See Lev v Chase Manhattan Bank, 751 N.Y.S.2d 484 (App. Div. 2002) (uncontradicted testimony by bank's vault manager as to security measures, undisputed fact that safe deposit box could only be opened with customer's key; no evidence of forced entry or unauthorized access).
11 See New York Banking Law §317.
12 See Goldman v Bank Leumi Trust Co. of New York, 513 F.Supp. 435 (S.D.N.Y. 1982).
13 See Radelman v. Manufacturers Hanover Trust, 306 N.Y.S. 2d 638 (App. Term 1969) (safe deposit lease executed by the plaintiff constitute[s] a valid contract between the parties herein; in the absence of fraud or undue influence, the parties are bound to the terms of the contract).
14 Agreements which express in unequivocal terms the intention of the parties to relieve a defendant of liability for negligence are enforceable. See Lago v. Krollage, 571 N.Y.S. 2d 689 (1991); Kaye v. M'Divani, 44 P.2d 371 (Cal. 1935).
15 Eller v. Nationsbank of Texas, 975 S.W.2d 803, 809-10 (Tex. Ct. App. 1998).
16 See, e.g., Uribe v. Merchants Bank of New York, 670 N.Y.S.2d 393, 396-97 (1998).
17 See Daskolopoulos v European American Bank & Trust Co., 481 N.Y.S.2d 100 (App. Div. 1984).
18 See 76 N.Y.Jur.2D §344 (2004) 
19 See Albert J. Schiff Assoc. v Flack, 417 N.E.2d 84 (N.Y. 1980).

VIII.   The Insurance Agents' and Brokers' E&O Report

Current Challenges Surrounding the New ACORD© Form 25 Certificate of Insurance Language Regarding Midterm Notice of Cancellation

 "A certificate of insurance is [supposed to be] an informational document issued by or, more commonly, on behalf of, an insurance company. The certificate indicates that an insurance policy exists of a certain type and limits. Certificates are simply snapshots of basic policy coverages and limits at the time of certificate issuance. Certificates are not intended to modify coverages or change the terms of the insurance

Yet certificates of insurance have long been a hotbed of E&O claims and lawsuits against insurance agents and brokers, and we have written about this topic previously in "The E&O Reporter." A new challenge for insurers, and insurance agents and brokers issuing certificates of insurance on their behalf has arisen in connection with the new ACORD© 25 P&C Certificate of Insurance regarding notice to third-parties with respect to midterm cancellation of the policies listed on the certificate.

In 2004, issues began to arise with respect to the previous ACORD© 24 Form language pertaining to midterm notice of cancellation to third-party certificate holders. ACORD© 24 read in pertinent part:

"Should any of the above described policies be cancelled before the expiration date thereof, the issuing insurer will endeavor to mail ___ days written notice to the certificate holder named to the left, but failure to do so shall impose no obligation or liability of any kind upon the insurer, its agents, or representatives."

However, increasingly aggressive third-party certificate holders unsuccessfully attempted to "read" themselves into the rights of the insurance policy and its notice of cancellation provisions. In response to insurers request, ACORD© formed an industry working group and developed new midterm notice of cancellation provisions for the ACORD© Form 25 Certificate of Insurance:

 "Should any of the above described policies be cancelled before the expiration date thereof, notice will be delivered in accordance with the policy provisions."

This language makes clear that the policy provisions control. Thus, if the third-party certificate holder is not expressly included in the body of the policy and/or is not named and attached to the policy by binder or endorsement, then the policy has no formal legal obligations to the third-party.

If the third-party is named in the body of the policy and/or attached by endorsement/binder, then the actual terms and conditions of that listed policy and/or endorsement will control and prevail as to how that third-party's interest is addressed, to include controlling the function and timing of any notice to the insured.

According to the PIA Insurance Agents Associations Business Issues Committee Technical Working Group memo dated December 13, 2010:

"Some insurers were concerned that the new language created an obligation since it uses the word 'will,' or that it didn't provide sufficient flexibility when the insurer, or through its underwriting permissions provided to their insurance producers on their behalf, allowed certain third-parties to revise a notice after the insurance policy was terminated. Some insurers reacted by issuing updated underwriting instructions regarding the language in Accord Form 25 which were unwittingly confusing and/or misguided from an insurance law perspective."

 E&O Loss Control Tips

 In light of the foregoing, insurance agents and brokers looking to reduce their E&O exposure are encouraged to do the following:

  • Continue to send a copy of all certificates issued (front and back) to each named insurer in the certificate and document your "file," including through the agency management system, that you have done so. This will arguably bind the insurer(s) to satisfy any insurance policy obligation to the third-party certificate holder in the event of a midterm cancellation of the insurance policies listed on the certificate.
  • The agency owner/principal assigned to insurance carrier compliance should confirm in writing with the underwriter for the insurer and/or wholesaler the insurers' underwriting instructions with respect to certificates of insurance. They should also confirm the insurer's current status of use and instructions for the new ACORD© 25 Certificate regarding midterm notice of cancellation to third-parties.

In writing to the insurer's and/or wholesaler's underwriter assigned to the agency, the agency should review its understanding of any underwriting guidelines concerning under what conditions and of what nature the insurer is willing to make accommodations to third-parties with respect to midterm notice of cancellation, and the instructions the agent is to follow in so doing. These instructions should be communicated to everyone in the agency handling certificates of insurance. A compliance check regarding these instructions should be part of the agency's periodic audit of certificate handling at the agency.

 20 See "Certificates of Insurance, Insurance Agents and Rolling Stone Syndrome," by Bill Wilson, CPCU, ARM, AIM, AAM, CPUC E-Journal November 2009.

 Professional Liability Monthly provides a timely summary of decisions from across the country concerning professional liability matters. The publication is distributed monthly via e-mail.  Cases are organized by topic, and where available, hyperlinks are included providing recipients with direct access to the full decision.  In addition, we provide the latest information regarding news in the professional liability industry.  We appreciate your interest in our publication, and welcome your feedback.  We also encourage you to share the publication with your colleagues.  If others in your organization are interested in receiving the publication, if you wish to receive it by regular mail or if you would like to be removed from the distribution list, please contact Brian R. Biggie.

Goldberg Segalla LLP is a Best Practices law firm with offices in Philadelphia, New York, Princeton, Hartford, Buffalo, Rochester, Syracuse, Albany, White Plains and on Long Island.  The Professional Liability Practice Group is comprised largely of seasoned trial attorneys who routinely handle all matters of professional liability claims and cases, with an emphasis in the areas of fidelity, directors and officers, insurance agents and brokers, nursing home defense, health care, and lawyers' professional liability. 

   The editors, Sharon Angelino, Brian R. Biggie, and Richard J. Cohen, appreciate your interest and welcome your feedback.

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