If you are required by law to perform an act, the act is not “voluntary.”  This proposition may seem obvious enough to most, but one insurer recently needed to be reminded of this common sense point by a Pennsylvania federal court inFirst Commonwealth Bank v. St. Paul Mercury Insurance Company.  There, the Court held that an insured did not violate a “voluntary payment” clause in its liability policy by refunding funds to a client’s account as required by a Pennsylvania statute.  This decision comes as welcome news to insureds, as well as to fans of the English language.

Liability policies often state that the insurer will not provide coverage for any “voluntary payment” made by the insured without the insurer’s consent.  As many courts have recognized, this common provision simply serves to prevent insureds from making gratuitous payments to claimants or entering into settlements without seeking the insurer’s consent.  In First Commonwealth, however, an insurer attempted to stretch the provision far beyond this understood meaning and apply it to a much different situation. 

In 2012, one of First Commonwealth’s clients was the victim of a malicious software attack.  This allowed a hacker access to the client’s on-line banking user name and password for an account at First Commonwealth.  Utilizing this information, the hacker made three transfers from the bank account – totaling in excess of $3.5 million.  The vast majority of these funds made their way to Russia and could not be recovered.

After these fraudulent transfers were discovered, First Commonwealth reimbursed the client for the full amount of its losses.  This payment was not made gratuitously or as part of a settlement.  Rather, First Commonwealth refunded its client’s lost funds because it was required to do so by an explicit Pennsylvania statute regulating unauthorized bank transfers.  First Commonwealth then turned to its insurer, St. Paul Mercury, for indemnification of its losses.

St. Paul Mercury denied coverage on the grounds that First Commonwealth had made a “voluntary payment” to its client without the insurer’s permission, thus breaching the policy.  After First Commonwealth filed a coverage action, St. Paul Mercury moved to dismiss on this same ground.

The Court denied the motion to dismiss, rejecting the argument that First Commonwealth’s reimbursement payment to its client violated the policy’s “voluntary payment” provision.  Citing to Black’s Law Dictionary, the Court explained that a “voluntary payment” means a payment that is “[u]nconstrained by interference; not impelled by outside influence.”  A regulation requiring payment, the Court aptly observed, is clearly an “outside influence” that caused the insured to make the payment in question.  As such, the payment was not “voluntary.”

There are many situations in today’s heavily regulated environment in which insureds are compelled to make payments or otherwise incur covered losses: ranging from financial institutions that are compelled to refund unauthorized or fraudulent transfers to corporations that are compelled to remediate environmental contamination.  An insured should not have to worry that by complying with such regulations it risks losing coverage.  By holding that a payment is not “voluntary” when compelled by law, the First Commonwealth Court helps protect insureds, at least in Pennsylvania, from this dilemma.

Although other courts around the country should likewise apply the plain meaning of the word “voluntary,” and find that compelled payments do not constitute “voluntary payments,” there is an additional step insureds can take to protect themselves against arguments to the contrary by their insurers. 

Most policies provide that the insurer cannot unreasonably withhold consent to voluntary payments.  Thus, insureds that are compelled to make payments should still consider seeking consent from their insurers for making such payments.  An insurer acting reasonably will have no choice but to consent.  If the insurer refuses consent, the insured can then argue not only that the payment was not voluntary but also that the insurer unreasonably withheld consent.  When dealing with an insurer trying to get off the hook for payment, having two arguments is better than one.