The Law

Legal Spotlight

A look at the latest decisions impacting the industry.
By: | May 1, 2014

Insurer Must Pay Claim

Executive Plaza’s office building in Island Park, N.Y. was severely damaged in a fire on Feb. 23, 2007. The cost to restore it to its previous condition came to more than $1 million.

Fortunately, Executive Plaza had $1 million in fire insurance coverage from Peerless Insurance Co., which gave Executive the choice between a payment for actual cash value or replacement cost. A dispute arose due to a two-year statute of limitations.

The policy stated the insurer would not pay for replacement cost for any loss or damage until the property was repaired or replaced; required that the repairs be made “as soon as reasonably possible;” and required that any legal action under the insurance had to be “brought within two years after the date on which the direct physical loss or damage occurred.”

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Peerless paid Executive the actual cash value of the destroyed building, which was $757,812.50, but Executive sought replacement value, wanting an additional $242,187.50. At that point, Peerless wanted verification that repairs were completed.

While Executive maintained it “acted reasonably” to make those repairs, it was not able to complete them before the second anniversary of the fire. On that date, it sued the insurer, asking the court to declare the insurance company liable for replacement costs up to the policy limit.

The case was moved to the federal court at the request of Peerless, and the suit was dismissed as “premature,” since the building was not yet finished. In October 2010, when the replacement building was completed, Executive again demanded payment. Peerless again refused, citing the two-year expiration, and a lawsuit again was filed.

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The case was again transferred to the federal court, and the U.S. District Court for the Eastern District of New York dismissed the lawsuit, ruling the policy “unambiguously bars any and all suits commenced more than two years after the date of the damage or loss.”

On appeal to the U.S. Court of Appeals for the Second Circuit, that court directed the state’s highest court, the New York State of Appeals, to decide, based on state law, whether an insured should be covered for replacement costs if the damaged property “cannot reasonably be replaced within two years.”

On Feb. 13, 2014, the court answered in the affirmative. “A ‘limitation period’ that expires before suit can be brought is not really a limitation period at all, but simply a nullification of the claim,” the court ruled. It said that once the insurer chose to provide replacement cost coverage, the company “may not insist on a ‘limitation period’ that renders the coverage valueless when the repairs are time-consuming.”

Summary: Peerless Insurance Co. must pay Executive Plaza the additional $242.187.50 on the replacement cost claim.

Takeaway: The policy interpretation will aid insureds when repairs or replacement are not reasonably possible within a policy’s statute of limitations.

RICO Defense Not Owed to Insured

The founder and CEO of an environmental contractor and consulting firm sought coverage from Savers Property & Casualty Insurance Co. under a “claims made and reported” professional liability insurance policy, after being named as a defendant in a civil Racketeer Influenced and Corrupt Organizations lawsuit.

Tristan Gour and his company, Industrial Safety and Environmental Services Inc., were accused of unlawfully participating in “a scheme to defraud and obstruct justice” by concealing the dumping of industrial solvents and other hazardous materials by Flexsteel Industries in Indiana, which caused groundwater contamination.

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Industrial Safety notified Savers of the RICO suit in May 2012, and the insurer denied a duty to defend or indemnify the insured, stating the claims against Gour involved alleged acts of misconduct that occurred before Feb. 1, 2005, the retroactive date for professional liability coverage.

Gour argued that the claim for defense was made and reported during the policy period; that the retroactive date didn’t apply to the professional services he rendered in the case; and that coverage was not barred because he wasn’t aware of the claim prior to the effective date of his policy.

The U.S. District Court for the Northern District of Indiana, South Bend Division, disagreed, and dismissed the case.

“Mr. Gour’s arguments are based on isolated words and phrases taken out of context,” the court ruled. “When the policy is viewed as a whole, it clearly and unambiguously excludes coverage from the claims asserted against Mr. Gour in [the underlying lawsuit].”

Summary: Savers did not have to pay up to the $3 million limit on general liability, pollution liability and professional liability coverage, minus a $2,500 deductible on each.

Takeaway: The ruling showed once again that insurance policies are to be viewed in their entirety when interpreting coverage, and should not focus on individual words, phrases or paragraphs.

No Indemnification for Ponzi Scheme

By the time the owners of Vesta Strategies pleaded guilty in federal court to wire fraud charges in 2010, they had looted their company of more than $20 million, and at its collapse, were unable to pay about $11.5 million to its remaining clients.

The company’s clients had used Vesta’s “client exchanges” as a way to avoid paying capital gains taxes when buying and selling property. The technique took advantage of IRS tax code provisions, but Vesta’s owners routinely invested their clients’ monies into a pooled account and used it for real estate ventures.

The enterprise, which was founded in 2004, acted like a Ponzi scheme, using pooled funds to repay individual customers until the real estate market collapsed in 2007, and funds were not available to meet the company’s obligations, according to court documents.

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Thomas Dillon, the court-appointed receiver for Vesta Strategies, filed suit against Continental Casualty Co., after the insurer denied payment under four insurance policies that had been issued to Vesta; its owners John Terzakis and Robert Estupinian; and Excalibur, the company’s East Coast marketing arm, which was 50 percent owned by Vesta, with the rest of the ownership shared by three others.

The insurance policies covered losses resulting from employee dishonesty up to $7.5 million, even when such losses were caused by Vesta or its partners. The policies covered losses that were discovered within or shortly after the expiration of the coverage periods, which ran from 2003 to 2007.

In March 2014, the U.S. District Court for the Northern District of California, San Jose Division, granted Continental’s motion to dismiss the case.

Even though it would be the defrauded clients who would benefit by the payment of the claim and not Vesta’s owners, the judge ruled that recovery cannot be granted “without violating the public policy against insuring the willful wrongdoing of the insured.”

“Moreover, permitting recovery in this case would essentially create an incentive for wronged victims to forgo holding the wrongdoers liable for their actions in exchange for the wrongdoers’ cooperation in pursuing an action against the insurance company, which, as may be the case here, has deeper pockets than the wrongdoer,” the court ruled.

Summary: Continental need not pay up to the $7.5 million policy limit for employee dishonesty.

Takeaway: California state law forbids the payment of insurance claims if it would reward criminal activities.

The late Anne Freedman is former managing editor of Risk & Insurance. Comments or questions about this article can be addressed to [email protected]

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The R&I Editorial Team can be reached at [email protected]