With 2022 in the books, we highlight and review some of the most noteworthy insurance coverage cases from the last year. COVID-19 business interruption cases continued to dominate the news. Whereas earlier decisions favored insurers, the tide seemed to turn as the year went on with an increasing number of appellate courts issuing decisions that favor policyholders. Directors and Officers coverage (“D&O”) also saw decisions in 2022 that will have a lasting impact on the scope of that coverage. And, Cyber insurance coverage continues to expand and evolve as the risks it strives to cover continue to expand. Other noteworthy cases likewise reinforced and, in some instances, expanded on foundational insurance coverage principles.
Without further ado, the Hunton Andrews Kurth LLP insurance team presents its overview of the top cases from 2022.
COVID-19 Business Interruption
As expected, COVID-19 business interruption coverage continued to be a hot button topic throughout 2022 and forecasts to continue that trend into 2023. Although the overall number of decisions still favor insurers, 2022 saw several huge wins for policyholders in cases at the appellate level (and in one instance, by a jury of their peers). In the latter, decisionmakers followed bedrock principles of insurance policy interpretation, applied to the unique facts and policy language in each case, and recognized the ever-developing science behind the effects of COVID-19, and its causative virus, SARS-CoV-2, on property. These recent favorable decisions provide some reason for optimism for policyholders as we enter 2023.
- Vermont Supreme Court Finds COVID-19 May Damage Property, Huntington Ingalls Indus., Inc. v. Ace Am. Ins. Co., 2022 VT 45 (Vt. Sept. 23, 2022)
The Vermont Supreme Court became the first state high court to recognize the quintessential factual causation issue in a case involving the alleged effect of a virus on property, confirming that such issues cannot be decided without evidence or experts. The Court likewise concluded that remedial measures undertaken to continue operations are indeed “repairs” under any reasonable meaning of that word.
- Texas Jury Finds Presence of SARS-CoV-2 Virus Causes “Physical Loss or Damage” to Property, Awards Over $48 Million to Baylor College of Medicine, Baylor Coll. of Med. v. XL Ins. Am., Inc., 2020-53316 (Harris Cnty. Dist. Ct. Sept. 21, 2022)
A Texas jury found that the presence of SARS-CoV-2 virus on the property of Baylor College of Medicine (“BCM”) caused “physical loss or damage” and resulting economic loss, triggering coverage under BCM’s commercial property insurance program. The jury awarded BCM over $48 million following a three-day trial; the award consisted of $42.8 million in business interruption, $3.3 million in extra expense and $2.3 million in damage to research projects. Critically, by confirming that COVID-19 did, in fact, cause “physical loss or damage”, the verdict effectively confirms the plausibility of policyholders’ allegations. In comments to Law360, Hunton insurance partner Michael Levine explained just how significant the jury’s finding was: “It shows what happens when the evidence actually is considered by ordinary people . . . No longer can a court credibly say, ‘It’s not plausible under the federal pleading standard’ when a jury has considered the evidence and said, ‘It happened.’”
- Marina Pac. Hotel & Suites, LLC v. Fireman’s Fund Ins. Co., 81 Cal. App. 5th 96 (2022) and Shusha, Inc. v. Century-Nat’l Ins. Co., 2022 WL 17663238 (Cal. Ct. App. Dec. 14, 2022)
In California, early COVID-19 decisions favoring insurers were balanced by more recent appellate decisions favoring policyholders.
In Marina Pacific, the California Court of Appeal for the Second District held that the policyholder “unquestionably pleaded direct physical loss or damage to covered property within the definition articulated [by California courts]—a distinct, demonstrable, physical alteration of the property.” The policyholder alleged that COVID-19 “not only lives on surfaces but also bonds to surfaces through physicochemical reactions involving cells and surface proteins, which transform the physical condition of the property.” In coming to its conclusion, the court was critical of a prior California appellate decision, United Talent Agency v. Vigilant Ins. Co., 77 Cal. App. 5th 821 (2022), in which the court found, “without evidence,” that COVID-19 does not damage property even though the policyholder alleged that it did.
The breadth of Marina Pacific was reaffirmed in a subsequent published California decision. In Shusha, the court reversed the trial court’s dismissal finding that the policyholder sufficiently alleged that COVID-19 physically altered its restaurant. The decision is particularly significant because the court’s finding assumed application of the highly controversial pro-insurer articulation of physical loss or damage—a distinct, demonstrable physical alteration of property. In recognizing the quintessentially factual causation question, the court held that, “it is a question of fact for a summary judgment motion or trial whether the restaurant closure and modifications resulted from damage caused by the COVID-19 virus or the government orders.” Thus, the court found error in the trial court’s attempt to determine causation based only on the pleadings, as so many courts have done across the country.
In light of the growing split in appellate authority, the Ninth Circuit recently certified a question to the California Supreme Court on whether the actual or suspected presence of the COVID-19 virus at an insured property can be “direct physical loss or damage” that would trigger coverage in commercial property insurance policies. The answer to the certified question will determine how the Ninth Circuit rules in Another Planet Entertainment LLC v. Vigilant Ins. Co. (Case No. 21-16093) and other pending cases, providing a very real possibility that the California Supreme Court will finally take up this coverage issue in 2023.
Directors & Officers
Maintaining its lead role on issues of corporate law and governance, Delaware broadened the scope of events that qualify as covered D&O “securities claims.” In contrast, in California a court attempted to expand the breadth of the bump-up exclusion when it applied it to exclude coverage for underlying shareholder suits against an acquired company alleging an inadequate price paid for the company in a transaction.
- Verizon Commc’ns Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 2022 WL 14437414 (Del. Super. Ct. Oct. 18, 2022)
A Delaware Superior Court recently expounded on what qualifies as a covered “securities claim” in Verizon. There, the court held that a bankruptcy trustee’s fraudulent transfer suit/claim against Verizon amounted to a covered “securities claim” under the company’s D&O policy, requiring Verizon’s insurers to cover the company’s $95 million settlement of claims accusing Verizon of luring a now-defunct company into a disastrous acquisition of Verizon’s old telephone equipment and infrastructure. Hunton insurance recovery partner Geoffrey Fehling recently commented that, “[t]he decision was a complete victory for Verizon and great news for policyholders seeking coverage for securities claims or contemplating coverage litigation in Delaware on similar issues.”
The trustee’s suit was brought derivatively on behalf of a Verizon-created entity that qualified as a covered organization under the policy. The court found the trustee to be a security holder for the entity, which meant the lawsuit brought by the acquiring company amounted to a covered securities claim.
The decision is good for policyholders and provides a path to D&O coverage for claims asserted in bankruptcy seeking to unwind transactions or pointing the finger at companies and their decision makers when a company becomes insolvent. The ruling is also positive for policyholders seeking coverage for securities claims or contemplating coverage litigation in Delaware on similar issues because they are not only limited to shareholder class actions or shareholders derivative claims. They can be broader.
- Ceradyne, Inc. v. RLI Ins. Co., 2022 WL 16735360 (C.D. Cal. Oct. 31, 2022)
The breadth of the bump-up exclusion was at issue again in 2022. A bump-up exclusion is generally implicated following the purchase of one corporation by another. Shareholders sue the company alleging that the purchase price paid by the acquirer was too low; implying that the agreed-upon acquisition price should be “bumped up” to a figure considered more fair by the shareholders of the acquired company. A bump-up exclusion works to exclude that increase in value from coverage.
Policyholders have previously obtained favorable rulings on the bump-up exclusion, including in cases where courts held the exclusion was inapplicable because they found it only applied to acquisitions. In assessing the application of the exclusion, courts have looked at the structure of the transactions, finding, for example, that insurers could not rely on a bump-up exclusion to escape coverage where it was unclear whether a merger deal could be considered an “acquisition” under the exclusion.
In 2022, insurers scored a win on the bump-up exclusion when a California federal court held that Liberty Mutual need not cover Ceradyne for an $11.3 million settlement the company struck to end shareholder lawsuits stemming from its acquisition by 3M. The court held that a bump-up exclusion in Liberty’s policy barred coverage. The exclusion barred coverage for “claim[s] alleging that the price or consideration paid or proposed to be paid for the acquisition . . . of all or substantially all the ownership interest in or assets of an entity is inadequate.” Ceradyne, the insured, argued that the exclusion was not intended to apply to a transaction in which Ceradyne was being acquired (as opposed to it being the acquiror of another entity). However, the court concluded that rendering the exclusion application was consistent with the purpose of the exclusion, which was to preclude coverage for amounts the insured becomes obligated to pay due to an increase in the purchase price of an entity, regardless of “whether the insured entity is the acquirer or the acquired.”
Ceradyne provides an expansive application of the bump-up exclusion that appears to reach beyond its terms and their plain meaning by permitting application without regard for the precluded entity’s role in the transaction, even though the roles were clearly defined. The decision stands in contrast to recent favorable bump-up exclusion decisions where the transactions at issue were not clear-cut acquisitions like 3M’s acquisition of Ceradyne.
2022 saw courts continue to face novel issues implicated by cyber insurance coverage policies. Such issues concerned disputes about coverage for cyberthreats which ranged from large-scale attacks, such as the 2017 NotPetya cyberattack, allegedly initiated by the Russian government, to computer fraud targeting small businesses with the intent to elicit fraudulent money wire transfers. The year ended with an interesting twist, with the Ohio Supreme Court extending the framework of pro-insurer COVID-19 business interruption decisions to issues of physical loss or damage to computer software.
- The War Exclusion Will Be a Leading Issue in the Months and Years Ahead, Merck & Co., Inc. et al. v. Ace Am. Ins. Co. et al., No. UNN-L-2682-18 (N.J. Sup. Ct.)
Insurance policies typically contain some form of a war exclusion, which generally bars coverage for loss and damage caused by “war,” “warlike,” and “hostile” actions. In Merck, a New Jersey Superior Court rejected insurers’ attempts to invoke a similar exclusion for “hostile or warlike action” to avoid covering losses claimed by Merck & Co. resulting from the 2017 NotPetya cyberattack. The decision was the first ruling on whether a traditional wartime exclusion bars coverage for a cyberattack.
The court’s conclusion that the war exclusion did not apply is a great result for policyholders. It ultimately rejects efforts by insurers to limit coverage in ways that policyholders did not envision when the insurance contract was originally written. Hunton partner Andrea DeField commented that the decision sends a message to insurers that they cannot “simply rely on an overbroad interpretation of a war exclusion to preclude coverage for cyber incidents, which often involve ties to threat actors tangentially affiliated with foreign adversaries.”
- Mondelez Int’l Inc. v. Zurich Am. Ins. Co., Case No. 2018 L 011008 (Ill. Cir. Ct. of Cook County, complaint filed Oct. 10, 2018)
Merck was followed by a successful settlement in Mondelez, a case in the Circuit Court of Cook County, Illinois. Similar to the insurers in Merck, the insurer, Zurich American Insurance Company, attempted to invoke a “war exclusion” as a basis for not paying business income losses suffered by snack food giant Mondelez International. Mondelez’s losses also involved losses suffered from the same incident as in Merck, the 2017 NotPetya attack. The parties ultimately settled what was a $100 million coverage dispute for an undisclosed amount after nearly four years of litigation and weeks of trial, but before the judge charged the jury with instructions on the law that applies to the facts of the case.
The decision to settle reinforces the ruling from Merck, which held that insurers could not rely on a similar war exclusion to avoid covering Merck & Co.’s losses from the same cyberattack. As noted by Hunton partner Andrea DeField, “Mondelez and Merck aren’t going to be the end of this issue . . . The new exclusionary endorsements that insurers are adding to policies—or that insurers are threatening to add—are going to add more uncertainty and more factual issues that are going to lead to coverage disputes.”
The decision also underscores the point that not all war exclusions and exceptions are created equal. Policyholders should take care to analyze these provisions at the policy procurement and renewal stage to determine the scope of the exclusion in the proposed policy and whether that specific insurer (or others) may be agreeable to endorsements that narrow the exclusion or introduce a critical exception to preserve coverage.
- A Win for Policyholders Who Are Victims of Fraudulent Bank Transfer Schemes, Ernst & Haas Mgmt. Co., Inc. v. Hiscox, Inc., 23 F.4th 1195 (9th Cir. 2022)
In Ernst, a property management company’s accounts payable clerk received several emails from her supervisor instructing her to pay various invoices. Unbeknownst to the clerk, these emails were part of a fraudulent scheme to elicit fraudulent bank transfers. The clerk issued payment for hundreds of thousands of dollars in “invoices” before becoming suspicious but, by then, the funds had already been irretrievably transferred. The insurer denied coverage on the basis that the company’s own employee had initiated the wire transfer of funds.
The district court sided initially with the insurer on the basis that the policy’s language required that the loss or damage “result directly” from the fraudulent activity. Because the business’s clerk was the one who initiated the wire transfer, the court reasoned that the loss resulted directly from an authorized act by the clerk, and not the fraudulent email to the clerk.
The Ninth Circuit reversed finding that the district court engaged in an “improperly narrow reading of the contractual language” when it concluded that, “a direct loss is limited to unauthorized computer use, like hacking.” The Ninth Circuit held that the insured’s loss was directly caused by the fraudulent transfer of funds at the time the employee transferred them, there was no intervening event and the computer fraud insuring agreement would cover the insured’s alleged loss.
In this modern digital era, email fraud schemes are commonplace. The application of the “direct” language under these coverages is an important, recurring issue that many insureds confront when they have a computer fraud loss. While a vigilant internal due diligence program, as well as other measures may prevent fraud, criminals are becoming increasingly more sophisticated and technologically advanced, ever increasing the need for a proper insurance program.
- Ohio Supreme Court Launches COVID-19 Holdings into Cyberspace; Denies Coverage for Physical Loss or Damage to Computer Software, EMOI Services, L.L.C. v. Owners Ins. Co., Case No. 2021-1529, 2022 WL 17905839 (Ohio, Dec. 27, 2022)
In EMOI, the Ohio Supreme Court held that ransomware-related damage to a medical billing company’s software was not covered under the company’s property insurance policy because the software did not sustain direct physical loss of or damage of the type required under the policy, which specified that the physical media storing the software suffer physical damage. The issue on appeal was whether a business property policy that included coverage for “direct physical loss of or damage to ‘media’,” applied when the policy specifically defined “media” to include “computer software,” but the only effect on the insured’s systems was its inability to decrypt the systems after receipt of a decryption key. Siding with the insurer, and despite the policy’s broad definition of “media,” the court found that software is an intangible item incapable of experiencing direct physical loss or direct physical damage.
The Supreme Court’s decision reversed an Ohio appellate court’s earlier ruling that the cyberattack triggered coverage under a commercial property insurance policy and built upon plainly distinguishable rulings in COVID-19 business interruption cases, such as Santo’s Italian Café, L.L.C. v. Acuity Ins. Co., 15 F.4th 398, 402 (6th Cir. 2021), where the Sixth Circuit found that government orders issued in response to the COVID-19 pandemic did not physically alter insured property.
The Ohio Supreme Court is the first state high court to explicitly rely on inherently flawed decisions from COVID-19 business interruption litigation to deny coverage for a non-COVID-19 insurance loss.1 Given the pervasiveness of those decisions, policyholders must be extra vigilant to guard against use of the COVID-19 decisions in other contexts, such as what occurred in EMOI.
Beyond the realm of COVID-19, D&O and Cyber insurance coverage issues, other significant cases were decided over the last year that have implications on coverage in various ways. As litigation resulting from the opioid epidemic has erupted, so too have related issues about coverage for the defense of these lawsuits. Elsewhere, courts have reinforced bedrock principles of insurance coverage, as reflected by the California Supreme Court’s Yahoo decision. Other courts have shown that some flexibility is required, as reflected by the First Circuit’s decision in Lionbridge, finding that a defense was indeed owed for allegations of trade secret misappropriation.
- Acuity v. Masters Pharm., Inc., 2020-1134, 2022 WL 4086449 (Ohio Sept. 7, 2022)
As opioid mass tort litigation has spread across the country, so too have issues about coverage for the defense of these lawsuits. In 2022, the Ohio Supreme Court held that an insurer did not have a duty to defend a lawsuit brought against drug distributor Masters Pharmaceutical Inc. by government agencies over the costs of responding to the opioid epidemic. The court held that the counties were specifically pursuing recovery of economic losses tied to the opioid epidemic — which are not covered — rather than personal injuries covered under the terms of the policy.
The decision highlights a restrictive application of the historically broad duty to defend. Indeed, but for the injuries and death caused by opioids, the underlying losses would not have been sustained and the underlying lawsuits would not have been brought.
- Unanimous California Supreme Court Affirms Breadth of Policy-Interpretation Rules in Confirming That CGL Policies Cover TCPA Liabilities, Yahoo Inc. v. Nat’l Union Fire Ins. Co. of Pittsburgh, PA, 14 Cal. 5th 58 (2022)
The California Supreme Court confirmed in Yahoo that contra proferentem (a rule of contract interpretation that states ambiguous terms should be construed against the drafter) and other rules of policy interpretation apply even where the policy wording is “manuscript,” as long as the subject wording is typical of standard-form policy terms. In response to the Ninth Circuit’s certified question about whether a commercial general liability policy (“CGL”) covers the defense of claims under the Telephone Consumer Protection Act (“TCPA”), the California Supreme Court, following a detailed assessment of California’s fundamental rules of policy interpretation, ruled for the policyholder, Yahoo.
In reiterating California’s rules of policy interpretation, the Court said that, while unambiguous policy provisions are enforced, when a provision is susceptible to more than one reasonable interpretation it is ambiguous; in those situations, the court must interpret the provision to protect the reasonable expectations of the policyholder. And if the court still cannot resolve the ambiguity, the provision is interpreted in favor of coverage. The Court held that both National Union and Yahoo’s proposed interpretations were reasonable and supported by other aspects of the policy. The Court further determined that the coverage grant, which must be broadly construed in favor of coverage, was ambiguous. As a result, the Court found that it must look to whether it was objectively reasonable for Yahoo to expect coverage. The Court held that the issue could not be resolved without further litigation about other aspects of the policy. The Court noted that, if additional litigation did not resolve the ambiguity, then coverage should be construed in Yahoo’s favor pursuant to the principle of contra proferentem.
Besides confirming coverage for Yahoo’s TCPA liabilities, the decision is significant for three other reasons. First, it confirms that contra proferentem and other principles of policy interpretation apply to a “manuscript” provision or endorsement that uses standard-form policy terms drafted by the insurance industry. Second, the decision confirms that even policy wording that is not solely drafted by the insurer should still be narrowly construed against the insurer and in favor of coverage. Third, it is a unanimous decision by the highest court in one of the biggest insurance markets in the country, one considered as a leader on insurance issues.
- Texas Duty to Defend: To Deviate or Not to Deviate, Bitco Gen. Ins. Corp. v. Monroe Guar. Ins. Co., 31 F.4th 325 (5th Cir. 2022) and Monroe Guar. Ins. Co. v. Bitco Gen. Ins. Corp., 640 S.W.3d 195, 199 (Tex. 2022)
Texas is among the minority of states that permit few, if any, deviations from the “eight-corners rule,” which provides that an insurer’s duty to defend must be determined from the complaint and the policy, without regard to extrinsic evidence or facts. In Bitco, the Fifth Circuit declined to consider extrinsic evidence in determining Bitco’s duty to defend and outlined when a court applying Texas law can deviate from the state’s strict eight-corners rule under the Monroe exception.
Bitco and Monroe issued CGL policies to 5D Drilling & Pump Services, Inc. for the years 2013 to 2014 and 2015 to 2016, respectively. 5D was sued when it allegedly failed to properly drill a well in the summer of 2014. Bitco and Monroe disputed over their duties to defend, with Monroe refusing to defend based on a stipulation between the parties that the loss occurred in November 2014, outside of its policy period. Bitco filed a declaratory action in the district court seeking a declaration that Monroe also owed a duty to defend and seeking to recover Monroe’s share of the defense costs. The district court granted summary judgment in Bitco’s favor based on the allegations of the underlying complaint. Monroe appealed to the Fifth Circuit, relying on a stipulation between the parties that the loss occurred in November 2014, outside of its policy period. But because the stipulation was extrinsic to the policy and underlying complaint, an issue arose as to whether the extrinsic stipulation could be considered in determining the duty to defend. The Fifth Circuit sought the Texas Supreme Court’s input into resolving this issue.
Ultimately, the Texas Supreme Court laid out what is now known as “the Monroe exception,” which permits consideration of extrinsic evidence provided the evidence (1) goes solely to an issue of coverage and does not overlap with the merits of liability, (2) does not contradict facts alleged in the pleading, and (3) conclusively establishes the coverage fact to be proved.
Subsequently, the Fifth Circuit declined to consider the stipulation on Monroe’s appeal and applied the newly established Monroe exception. The Fifth Circuit found that the stipulation between Monroe and 5D would impermissibly overlap with determining the merits of liability because “[a] dispute as to when property damage occurs also implicates whether property damage occurred on that date, forcing the insured to confess damages at a particular date to invoke coverage, when its position may very well be that no damage was sustained at all.”
These cases demonstrate that courts applying Texas law are still bound by strict standards as to when they may permit extrinsic evidence in determining the duty to defend. To date, Texas permits extrinsic evidence in very few instances.
- Lionbridge Techs., LLC v. Valley Forge Ins. Co., 53 F.4th 711 (1st Cir. 2022)
In Lionbridge, the First Circuit unanimously reversed a trial court’s summary judgment decision which found that Valley Forge Insurance Company had no duty to defend under a commercial general liability insurance policy in connection with a trade secrets lawsuit filed against Lionbridge by one of its competitors in the U.S. District Court for the Southern District of New York. The trial court had granted the insurer’s summary judgment motion finding that there was no duty to defend because there was no allegation of any injury from slander, libel or disparagement of goods, products or services that would constitute a covered claim under the policy’s personal and advertising injury liability section.
In reversing the trial court’s decision, the First Circuit reaffirmed liability insurers’ broad duty to defend policyholders against actions involving claims that might be covered, which the trial court had cast doubt on. Indeed, the First Circuit held that a single paragraph in the underlying complaint “roughly sketched” a claim for defamation covered by Lionbridge’s policy, even though the complaint did not include a specific cause of action for the covered claim, which was sufficient to trigger Valley Forge’s duty to defend.
The Lionbridge decision is particularly significant for policyholders because it clearly extends the broad duty to defend to claims that are embodied in allegations, even though not explicitly pleaded. The decision makes clear, therefore, that all of the alleged facts matter when determining the duty to defend, and that the duty will be triggered when any of the allegations potentially come within the relevant scope of coverage.