HNRK Coverage Corner

A recent decision from the U.S. District Court of Western District of Washington  touches on a number of important insurance coverage issues:  policy reformation, the effect of an insured’s late notice of a claim, and the insurer’s burden to prove applicability of a policy exclusion. In General Casualty Company of Wisconsin v. Reed Hein & Assoc. LLC et al., the court’s consideration of these issues resulted in opposite outcomes for two insurers. While the insured’s CGL carrier (General Casualty) successfully avoided a duty to defend, the D&O insurer (RSUI) was found to have breached its defense obligations.

Background

Reed Hein marketed “timeshare exit services” across North America, offering to help consumers get out of timeshare contracts before the end of the term. In 2020, the State of Washington filed a lawsuit against Reed Hein alleging unfair and deceptive practices in the advertising and handling of its services.

In October 2021, Brain and Kerri Adolph (the “Adolphs”) filed class action lawsuit alleging that Reed Hein defrauded consumers through false advertising and misappropriated client funds by treating pre-service payments as earned income instead of holding them in escrow.

In April 2022, the parties reached a settlement requiring Reed Hein to pay consumers the amounts they paid to the company, plus treble damages, fees, costs, and interest. As part of the settlement, Reed Hein assigned the Adolphs the right to pursue breach of contract claims against the company’s liability insurers, which had disclaimed coverage.

The Policies at Issue

General Casualty issued primary and umbrella CGL polices to Reed Hein for 2020-2021 and 2021-2022 policy periods. All policies except the 2021-2022 primary policy contained a personal and advertising injury exclusion, which in relevant part, precluded  coverage for claims asserted in the class action “under theories of right to privacy, loss of the right to use dwellings, disparagement of services, or exposure to malicious prosecutions.” General Casualty agreed to defend Reed Hein under the 2021-2022 primary policy subject to a reservation of rights, noting that the personal and advertising injury exclusion had been inadvertently left off the policy.

RSUI issued D&O policies for the same policy years, each containing a prior acts exclusion. In 2021, Reed Hein notified RSUI of lawsuits filed earlier that year. RSUI denied coverage, citing late notice and the prior acts exclusion. When Reen Hein later tendered the class action in November 2021, RSUI determined that the lawsuit arose from the same or interrelated wrongful acts alleged in prior lawsuits  and therefore denied coverage on the same grounds.

Procedural Posture

General Casualty brought filed a lawsuit seeking reformation of the 2021-22 primary policy to include what it asserted was an inadvertently-omitted exclusion for “personal and advertising injury”. The Adolphs counterclaimed against General Casualty and brought third-party claims against RSUI for breach of contract, bad faith, statutory violations, and sought declaratory relief regarding both insurers’ duties to defend.

The Adolphs moved for summary judgment for, among other claims, their breach of contract claims against both insurers. General Casualty moved for summary judgment for its duty to defend and reformation of the 2021-22 primary policy to include the personal and advertising injury exclusion.

General Casualty Did Not Owe a Duty to Defend

The court granted General Casualty’s summary judgment regarding its duty to defend.

Policy Reformation

Analysis of a claim for insurance coverage begins with the language of the policy.  But what happens when the language fails to reflect the parties’ intent?  As previously discussed on this blog (see here and here), under the doctrine of reformation of contract a court may correct a “scrivener’s error” or other mutual mistake in a contract to reflect the parties’ actual intent.  As the court in Hein Reed explained, under Washington state law, “[a] party seeking reformation . . . must provide ‘clear, cogent and convincing evidence’ of the mistake, “and if doubts exist as to the parties’ intent, reformation is not appropriate.”  

Here, the court held that General Casualty had provided undisputed, clear and convincing evidence of the parties’ mutual intent to include the personal and advertising injury exclusion in the 2021-2022 policies . The court found  Reed Hein knew and understood that, due to its preexisting claims, it could not obtain general liability coverage without the personal and advertising injury exclusion in 2020. There was also evidence that Reed Hein was seeking an “automatic renewal” of its existing policy rather than a different policy in 2021. Therefore, the court reformed the 2021-2022 primary policy to include the personal and advertising injury exclusion.

In the past, we have seen the doctrine of reformation applied to expand coverage rather than curtail it.  An insurer would likely argue that what’s good for the goose is good for the gander.  But of course, the insurer drafts the policy, and any ambiguities are generally construed against the insurer.

No Allegations of Property Damage

The court held that the class action complaint was not covered by the General Casualty CGL policies as reformed. The class action lawsuit’s theories of liability for violations of the right to privacy, loss of the right to use dwellings, disparagement of services, and exposure to malicious prosecutions were all precluded from coverage due to the personal and advertising injury exclusion.

The court also rejected the argument that the claims alleging misappropriation of funds were covered “property damage,” which the policies defined to include “[l]oss of use of tangible property that is not physically injured.” The court held that “financial assets lacking physical form and characteristics are not tangible property for the purposes of insurance policy coverage” and therefore the misappropriation of funds did not trigger coverage.

Notably, despite holding that General Casualty had no duty to defend, the court allowed the Adolphs’ bad faith claim to proceed.  Washington is one of a handful of states that recognize a potential cause of action for bad faith claims handling even in the absence of coverage.  See Coventry Assocs. v. Am. States Ins. Co., 136 Wn. 2d 269, 279 (1998) (“an insured may maintain an action against its insurer for bad faith investigation of the insured’s claim . . . regardless of whether the insurer was ultimately correct in determining coverage did not exist”).  The court found this case presents an “unusual situation,” and a “reasonable jury could find for either party”:  one the one hand, “[a] reasonable jury could find that General Casualty prioritized its own interests over Reed Hein’s the more than 11 months between receiving the tender and issuing a coverage decision; on the other hand, “a reasonable jury could conclude that the insurer’s effort to investigate the missing exclusion before issuing a decision was not frivolous or unfounded.”   

RSUI Breached Its Duty to Defend

The court granted summary judgment against RSUI for breach of contract, rejecting its arguments to avoid the duty to defend based on late notice of the claim and the application of the policy’s Prior Acts Exclusion two justifications that RSUI provided to deny coverage were not valid.

Late Notice

Under Washington’s “late tender rule,” an insurer cannot deny coverage solely based on late notice. Under Mut. Of Enumclaw Ins. Co. v. USF Ins. Co., 164 Wn.2d 411 (2008),  “an insurer must perform under the insurance contact even where an insured breaches the timely notice provision of the contract unless the insurer can show actual and substantial prejudice due the late notice.” Here, RSUI’s own claims adjuster testified that RSUI did not experience any prejudice.

Failure to Prove the Prior Acts Exclusion Applied

The policy’s Prior Acts Exclusion, provides:

The Insurer shall not be liable to make any payment for Loss in connection with any Claim made against any Insured that alleges, arises out of, is based upon or attributable to, directly or indirectly, in whole or in part, any actual or alleged Wrongful Acts which first occurred prior to May 1, 2018.

The Washington courts had yet to interpret such an exclusion. Cited a Ninth Circuit decision that interpreted a similarly worded exclusion under California law,  the court held that the exclusion did not preclude coverage for claims asserting wrongful acts committed after the specified date, even if those acts related to conduct that occurred before the prior acts date.  See Opus Bank v. Liberty Ins. Underwriters, Inc., 621 Fed. Appx. 405 (9th Cir. 2015).  Here, because the class action complaint alleged at least some wrongful conduct that occurred after the date identified in the Prior Acts Exclusion, and because RSUI failed “to identify any case law from other jurisdictions supporting its position,” the court held RSUI could not meet its burden to avoid the duty to defend based on the exclusion.  Accordingly, the court granted partial summary judgment to the Adolphs for breach of the duty to defend, with the amount of damages to be determined at trial.