Social Media and Discovery: Accessing Password Protected Material

Social media is everywhere, including, with increasing frequency, in lawsuits, particularly those involving employment-related claims. For example, employers sued by potential, current, and former employees are seeking social media information to learn if on-line postings by those employees on social media sites contradict statements or contentions made by them in their lawsuit. For their part, plaintiff-employees are seeking social media information to try to bolster their claims, such as looking for information from social mediate sites to show a pattern of allegedly harassing conduct by a supervisor or co-worker that extends beyond the workplace.

In a recent case, Zimmerman v. Weis Markets, Inc., No. CV-09-1535, 2011 WL 2065410 (Pa. Com. Pl. May 19, 2011), the trial court permitted the defendant employer to access the plaintiff’s password-protected on-line information. The plaintiff brought suit against his former employer after he injured his leg on the job while operating a forklift. The plaintiff sought damages for lost wages, lost future earning capacity, pain and suffering, scarring and embarrassment. The plaintiff claimed that he could no longer participate in certain activities and that his injuries affected his enjoyment of life. At his deposition, the plaintiff stated that he never wore shorts because he was embarrassed by the scar on his leg from the accident. However, the employer discovered on various publically-available social media websites, pictures posted by the plaintiff where his scar was clearly visible.

The defendant pursued this matter further, filing a motion to obtain access to private portions of the plaintiff’s social media sites and posts. The defendant argued that there may be other relevant information contained on those sites that would pertain to the plaintiff’s damages claim. The defendant sought the plaintiff’s passwords, user names and login names. Not surprisingly, the plaintiff opposed the defendant’s efforts to gain access to his private social media sites, arguing that his privacy interest outweighed any need to obtain discoverable material.

The court granted the defendant’s motion, finding that the plaintiff’s privacy interests did not outweigh the defendant’s need to obtain the information, that liberal discovery is favored, and the pursuit of truth is paramount. The court noted that it was the plaintiff who placed his physical condition at issue, and the defendant therefore has a right to find out information about the plaintiff’s condition. The court further reasoned that because the plaintiff posted the information to share with others, he could not now claim a reasonable expectation of privacy.

The court was careful to note, however, that its ruling should not be interpreted as a blanket entitlement to dig into employees’ private social media activities in every case, or that the court would allow “fishing expeditions.” Rather, the court clarified that it would consider an application seeking private social media information if the party seeking the material could make a threshold showing that the publicly accessible portions of the site indicate that there would be further relevant postings in the non-public portions. Thus, what the court essentially held was that if the plaintiff opens the door by posting publically-available information relevant to the lawsuit, private portions of a plaintiff’s social media are fair game. At bottom, this makes sense, however, watch for this rationale to be tested further, and perhaps expanded.

Court Compels Production of Personal Emails from Company Systems Citing Lack of Reasonable Privacy Expectation

On May 23, in SEC v. Reserve Management Co. Inc.,[1] the U.S. District Court for the Southern District of New York ruled that an employee does not have a reasonable expectation of privacy with respect to communications with a spouse through an employer’s email system. In reaching its decision, the court employed the four-part test from In re Asia Global Crossing Ltd.[2] to determine if the employee had a reasonable expectation of privacy. Key to the court’s analysis was the presence and actual notice to employees of an email policy that both forbade personal communications and warned employees of possible disclosure of company-controlled email communications.

Background

Reserve Management Co, Inc. (RMCI), under the leadership of its president, Bruce Bent II, managed a money market mutual fund known as the Reserve Primary Fund (Fund). RMCI invested $785 million of the Fund’s assets in Lehman Brothers debt. Just days after Lehman Brothers’ bankruptcy announcement, the Fund’s net asset value dropped to less than $1 per share. In response to RMCI’s handling of communications with investors regarding the Fund’s vulnerability to Lehman Brothers and its effect on investor assets, the Securities and Exchange Commission (SEC) filed fraud charges against RMCI. During discovery, RMCI withheld approximately 60 emails between Mr. Bent and his wife, asserting the marital communications privilege. The SEC subsequently moved to compel production of these emails.

In determining whether there was a valid marital communications privilege claim, the court found that it was undisputed that the Bents were married and that they intended to convey messages to each other. However what was in dispute was whether their communications were made in confidence.

Privacy of “Personal” Data in the Courts

The question of whether an employee has a privacy interest in “personal” data on company systems has been addressed by many courts in the past decade. Generally, courts have held that content maintained on company-owned systems is the property of the company. However, there have been some notable exceptions. In the Stengart case,[3] the Superior Court of New Jersey found that company ownership of a computer was not determinative of whether an employee’s otherwise privileged emails were company property. Instead, the court balanced the employer’s legitimate business interests against the attorney-client privilege.

Additionally, a growing line of cases affords protection to employees who may reasonably have expected privacy when using company IT systems. In Asia Global Crossing, the court set forth a four-factor test to assess the reasonableness of an employee’s privacy expectation in personal email transmitted over, and maintained on, a company server. The test poses four questions:

1.      Does the company maintain a policy banning personal or other objectionable use?

2.      Does the company monitor the use of the employee’s computer or email?

3.      Do third parties have a right of access to the computer or emails?

4.      Did the company notify the employee, or was the employee aware, of the use and monitoring policies?

This test has been adopted by a number of courts faced with the task of determining the reasonableness of privacy expectations. As the Reserve Management court pointed out, “the cases in this area tend to be highly fact-specific and the outcomes are largely determined by the particular policy language adopted by the employer.”

The Four-Factor Test and RMCI

Applying the four-factor test to determine whether Mr. Bent had a reasonable expectation of privacy in his emails with his wife, the court analyzed whether RMCI maintained a policy regarding personal use of company email. The court rejected RMCI’s contention that any policy was merely aspirational, finding that the policy clearly banned personal use of the company email system:

Employees should limit their use of the e-mail resources to official business. . . . Employees should . . . remove personal and transitory messages from personal inboxes on a regular basis.

Focusing intensely on the policy’s language, the court cited prior opinions analyzing obligatory policy language, as well as dictionary definitions. Ultimately, the court determined that RMCI’s policy unequivocally banned the personal use of company email, and that Mr. Bent violated this policy by communicating with his wife over RMCI’s systems.

The court next addressed the second factor of the Asia Global Crossing test-whether the employer monitors the employee email. While stating that the company will not “routinely monitor employee’s e-mail and will take reasonable precautions to protect the privacy of e-mail,” RMCI’s policy further stated that RMCI reserved “the right to access an employee’s e-mail for a legitimate business reason . . . or in conjunction with an approved investigation.” Because RMCI reserved the right to access email accounts, the court found that RMCI satisfied the second factor of the Asia Global Crossing test. Elaborating, the court pointed out that where an employer reserves this right, courts often find the employee has no reasonable expectation of privacy.

The third factor of the Asia Global Crossing test asks whether third parties have rights to access employee emails. Once again, the RMCI email policy addressed this, stating:

Employees are reminded that client/public e-mail communications received by and sent from Reserve are automatically saved regardless of content. Since these communications, like written materials, may be subject to disclosure to regulatory agencies or the courts, you should carefully consider the content of any message you intend to transmit.

The court found that this provision gave clear notice to Mr. Bent that his communications over the company email system were subject to disclosure. In its analysis, the court noted that RMCI operates in the heavily regulated financial sector, and that regulatory action was reasonably foreseeable.

The fourth factor-employer notice and employee awareness of the company use and monitoring policy-was not in contention. The defendants conceded that Mr. Bent was aware of the policy.

Having answered all four questions in the affirmative, Mr. Bent was deemed not to have had a reasonable expectation of privacy in emails he sent or received over RMCI’s email system. Consequently, the communications with his wife were deemed not confidential and the marital communications privilege did not apply. Granting the SEC’s motion, the court ordered RMCI to produce the withheld emails between Mr. Bent and his wife, which resided on the RMCI email servers and data archives.

Conclusion

This case serves to remind organizations of the importance of email policies and compliance. The commingling of business and private communications can expand the scope of discovery and expose a company to liability for an employee’s casual, careless remarks, which the employee may have considered to be private. Even though Mr. Bent believed that his emails with his wife were not business related, and would never be read by anyone else, the court found that this was not a reasonable belief and ordered disclosure.

As in Stengart, companies may be at a disadvantage in litigation with an employee or former employee whom the court finds had a reasonable expectation of privacy. In such cases, not only will a company have no right to emails on its own system, but it may also need to sequester any privileged communications identified during discovery and to disclose the discovery to opposing counsel.

The overarching lesson from these cases is that companies should have in place comprehensive, robust computer and email usage policies. Of course, these policies are only effective when they are clearly articulated and publicized. As well as increasing compliance, a formal training program can eliminate questions regarding notice. Finally, companies should strongly consider using an acknowledgement mechanism to demonstrate that employees received, reviewed, and understood the policy.

Generic Drug Manufacturers And Failure To Warn: What duty is there after Pliva v. Mensing?

The Supreme Court ruled on June 23, 2011, that generic drug manufacturers cannot be sued for a failure to warn under state tort law, as long as their labeling complies with the FDA mandated labeling for the innovator drug product. While the Court had previously declined to find that federal regulation and approval of drug labeling of an innovator drug preempted state tort law in Wyeth v. Levine, 555 US 555 (2009), the Court ruled 5-4 in Pliva that the comprehensive scheme for approval of generic drugs under the 1984 Hatch-Waxman amendments required generic manufacturers to use the same labeling as the innovator brand name product. Since the law and FDA regulations, as conceded by the Food and Drug Administration (FDA), preclude a generic company from obtaining approval of labeling different from the innovator brand name product, the Court held it was not possible for a generic manufacturer to comply with both federal and state law. As such, under the doctrine of impossibility, they ruled federal law was supreme and state tort laws on failure to warn were preempted. In so finding, they held that the issue of “impossibility” turns on whether the private party could independently do under federal law what state law requires of it. In this case, they held that generic manufacturers could only ask FDA to change labeling and could not do so without FDA approval, and thus could not act independently.

As stated by the Court:

The non obstante provision suggests that pre-emption analysis should not involve speculation about ways in which federal agency and third-party actions could potentially reconcile federal duties with conflicting state duties. When the “ordinary meaning” of federal law blocks a private party from independently accomplishing what state law requires, that party has established pre-emption.

The Court ruled at length upon the FDA’s interpretation of its authority. FDA conceded that a generic company could not obtain approval of a CBE-30 (Changes Being Effected in 30 day supplement) to add additional warning language to labeling, and that its only alternative if it chose to do so was to propose new warnings to the FDA if they believed they were necessary. At that point the Agency is to work with the brand name manufacturer “to create a new label”. The appellant manufacturers and FDA did not agree as to whether there was such a duty. The Court did not rule on that issue, since it found that pre-emption applies, even if there were such a duty.

Both the majority opinion conceded, and the dissent made a big point of, the fact that the result of the decision resulted in a situation where an individual’s right to seek relief for failure to warn turns on whether he/she took a generic or brand name of a product. As noted in the majority opinion:

We recognize that from the perspective of Mensing and Demahy, finding pre-emption here but not in Wyeth makes little sense. Had Mensing and Demahy taken Reglan, the brand-name drug prescribed by their doctors, Wyeth would control and their lawsuits would not be pre-empted. But because pharmacists, acting in full accord with state law, substituted generic metoclopramide instead, federal law pre-empts these lawsuits. See, e.g., Minn. Stat. §151.21 (2010) (describing when pharmacists may substitute generic drugs); La. Rev. Stat. Ann. §37:1241(A)(17) (West 2007) (same). We acknowledge the unfortunate hand that federal drug regulation has dealt Mensing, Demahy, and others similarly situated.
But “it is not this Court’s task to decide whether the statutory scheme established by Congress is unusual or even bizarre.” Cuomo v. Clearing House Assn., L.L.C., 557 U. S. ___, ___ (2009) (THOMAS, J., concurring in part and dissenting in part) (slip op., at 21) (internal quotation marks and brackets omitted). It is beyond dispute that the federal statutes and regulations that apply to brand name drug manufacturers are meaningfully different than those that apply to generic drug manufacturers. Indeed, it is the special, and different, regulation of generic drugs that allowed the generic drug market to expand, bringing more drugs more quickly and cheaply to the public. But different federal statutes and regulations may, as here, lead to different pre-emption results. We will not distort the Supremacy Clause in order to create similar preemption across a dissimilar statutory scheme. As always, Congress and the FDA retain the authority to change the law and regulations if they so desire.

Given this ruling, what duty do generic manufacturers have if they become aware of new information as to the safety of a drug? Generic drug manufacturers still have pharmacovigilance duties under 21 C.F.R. § 314.80, and may become aware of data that they believe requires a labeling change. While the Court did not rule there was a duty to take any action, the FDA made it clear in their briefing that there was an obligation to bring such information to their attention and request a label change. As stated by the Court:

According to the FDA, the Manufacturers could have proposed—indeed, were required to propose—stronger warning labels to the agency if they believed such warnings were needed. U. S. Brief 20; 57 Fed. Reg. 17961. If the FDA had agreed that a label change was necessary, it would have worked with the brand-name manufacturer to create a new label for both the brand-name and generic drug. Ibid.

The agency traces this duty to 21 U. S. C. §352(f)(2), which provides that a drug is “misbranded . . . [u]nless its labeling bears . . . adequate warnings against . . . unsafe dosage or methods or duration of administration or application, in such manner and form, as are necessary for the protection of users.” See U. S. Brief 12. By regulation, the FDA has interpreted that statute to require that “labeling shall be revised to include a warning as soon as there is reasonable evidence of an association of a serious hazard with a drug.” 21 CFR §201.57(e).
According to the FDA, these requirements apply to generic drugs. As it explains, a “ ‘central premise of federal drug regulation is that the manufacturer bears responsibility for the content of its label at all times.’ ” U. S. Brief 12–13 (quoting Wyeth, 555 U. S., at 570–571). The FDA reconciles this duty to have adequate and accurate labeling with the duty of sameness in the following way:
Generic drug manufacturers that become aware of safety problems must ask the agency to work toward strengthening the label that applies to both the generic and brand name equivalent drug. U. S. Brief 20.

There are questions left open on this issue, including the lack of any clarity on whether this is indeed a statutory duty. If it is, what is the consequence if a generic manufacturer becomes aware of a safety issue with one of its product and does not act to bring the matter to FDA? In addition to the potential misbranding charges which FDA’s interpretation suggests, will the knowing failure to bring the matter to FDA result in liability under a negligence or other theory? Or is the only possible liability a potential violation of the Federal Food Drug and Cosmetic Act? (the Act) Would a plaintiff claiming a generic manufacturer did not pursue its duty to request a label change face the defense that there is no private right of action with regard to a generic manufacturer’s duty as outlined by FDA?

In addition, as discussed at same length in the dissent, what happens when the brand name product is discontinued as frequently occurs after generics enter the market? Who, if any one, may be exposed to failure to warn issue? If, as FDA frequently does, FDA lists the first generic as the Reference Listed Drug for purposes of bio-equivalence studies, does that “generic” manufacturer get put in the place of the brand name company in the analysis? While it may appear to be the last word on generic drug manufacturer labeling for failure to warn under state law, Pliva may not totally absolve generic drug manufacturers from product and other liability if they become aware of safety data and do not act to address the issue.

Avoiding Coverage Gaps from Professional Services

Commercial general liability (CGL) policies typically provide coverage for, among other risks, bodily injury, property damage and advertising/personal injury. Many CGL policies exclude coverage for liability stemming from an insured’s “professional services.” These exclusions are utilized because it is thought that such risks should, in theory, be covered under the insured’s professional liability policies. Professional liability insurers, in turn, are careful not to accept coverage for risk they believe should be covered under the insured’s CGL policy, so they sometimes exclude coverage for bodily injury and property damage.

While one would think that obtaining separate coverage for bodily injury, property damage and personal/advertising injury, on one hand, and professional liability, on the other, would eliminate any gaps in coverage, in practice the coverages do not always perfectly dovetail, nor is it always clear which coverage is applicable to a given situation. While these kinds of coverage issues are nothing new, they have become much more commonplace as companies have become more diversified, e.g., as product-driven companies seek to support sales by providing a broader range of technical services. And, such categorization issues can become critical where the company not only engages in activities that blur the distinction but has purchased coverage for only one of the risks, usually general liability coverage.

Companies that run into problems with the potential crossover of CGL and professional liability coverage generally fall into two basic risk profiles. The first profile includes those companies that acknowledge that their business activities involve risks covered by both CGL and professional liability policies and have therefore purchased both types of coverage, but whose policies have not been properly tailored to avoid gaps between the coverages. The second profile includes those companies whose business activities are evolving to become more or less akin to “professional services,” but whose coverage has not adapted to reflect the changing nature of their activities.

Identifying these potential risks and finding solutions can help avoid unwanted surprises when a claim arises and also make sure that a company?s insurance will be available as intended.

A Malleable Concept

Outside of traditional categories of “professionals” like doctors, architects and engineers, no clear consensus exists as to what constitutes “professional services.” Policies usually define “professional services” as “providing services to another for compensation,” but that definition is far from universal and, in those instances when it is adopted, the scope of the definition is not always self-evident. Thus, the issue of whether an activity constitutes professional services boils down to a “you will know it when you see it” standard, offering little comfort to a policyholder. Examples from a sampling of industries illustrate the problem:

1.  Technology. 

A company develops and sells to commercial airlines a device used to measure airspeed. In addition to the sale of the product, the company provides the airline with consulting services for an additional fee. The device is implicated in a large-scale disaster, and the passengers’ families bring suit against the technology company.

2.  Life sciences.

 A pharmaceutical company enters a joint venture with a biotechnology company to perform a clinical trial of an HIV vaccine in Argentina. As a result of a data breach in the United States, all of the participants’ names and contact information are published on the internet as persons infected with HIV. The plaintiffs file suit in the United States alleging defamation and breach of privacy under various common law and statutory theories.

3.  Construction. 

A construction firm provides on-site construction management services. Following a request for information from the company doing the excavation work, the on-site team collectively decides additional shoring is needed. During the course of this work, there is a collapse which causes significant project delays and damage to an adjacent structure. The owner files suit for cost-overruns and delays and the adjacent property owner sues for damage to its building.

Each of these examples involves a risk covered under most commercial general liability policies. There also is, however, an element of “professional services” in each of the examples. Which program would respond to each of these losses? The CGL program? The professional liability program? Both? Neither? The answer of course depends on numerous factors, some of which are discussed below.

Why It Matters

Before discussing the factors that influence which coverage will respond to the loss, it is important to consider why it matters.

1.  Loss of coverage. 

While it is possible for a mixed professional services/general liability claim to fall completely into a gap between an insured’s professional and general liability programs, the more likely cause of a total loss in coverage would be if the loss resulted from an insured acting in some capacity arguably not contemplated by its carriers. In that regard, it is possible for a professional service provider to lose coverage under its professional policy as a result of a business activity arguably not “professional” in character, such as an architecture firm that begins designing and selling furniture that causes bodily injury. In general, however, more professional service providers carry CGL coverage than non-professional service providers carry professional liability insurance. Therefore, problems are more likely to occur when a company not generally regarded as a professional services provider (e.g., a distributor) engages in some activity that arguably could be characterized as “professional” in nature (e.g., point-of-sale consulting services).

A total loss of coverage may also result if the insured fails to timely notify the appropriate carrier of its loss. The risk of a notice-related loss of coverage is much greater under a professional liability policy, as such policies are typically written on a claims-made or claims-made-and-reported basis (see additional discussion of this below). And, the risk of a notice-related loss is only exacerbated when the “professional services” aspect of the claim is subtle or the party responsible for notifying the carrier does not understand or appreciate the scope of coverage afforded under the company’s professional liability policy.

2.  Available limits/cost.

As a general matter, policyholders carry significantly higher limits for CGL coverage than for professional liability coverage, and typically secure the higher CGL limits at a relatively lower cost per dollar of coverage. If a professional liability program is the only source of insurance for a serious multiple-person bodily injury or large-scale property damage case, the limits of such policy therefore are likely to be insufficient unless the program was specifically designed to handle such losses.

3.  Defense costs.

CGL policies frequently provide for supplemental defense costs, i.e., the payment of defense costs without eroding policy limits. Professional liability policies, by contrast, usually provide defense costs within the limits; these are often referred to as “burning limits” policies, as the payment of defense costs reduces (burns) the policy limits. With monthly defense costs often reaching $500,000 to $1 million in high-stakes cases, this difference can be substantial as many professional liability policies do not have sufficient limits to cover defense costs being incurred at these levels let alone subsequent adverse judgments or settlements.

4.  Occurrence v. claims-made-and-reported.

CGL policies are typically written on an occurrence-basis, whereas professional liability policies are almost always written on a claims-made-and-reported basis. Therefore, prompt and timely reporting of claims or potential claims is typically much more important under professional liability policies than under CGL policies. This distinction could prove very important when, for example, a particular suit is initially identified as a CGL loss, but further review reveals a basis for coverage under the professional liability program. If sufficient time passed for the professional liability program in effect when the suit was filed to lapse and a new program to incept, the failure to provide notice might result in a lost opportunity for coverage under either year?s professional liability program.

Key Policy Provisions

1.  Definition of professional services. 

The definitions of “professional services” in a policyholder’s CGL and professional liability policies should be coextensive to ensure perfect dovetailing of coverage. If, for example, the definition of “professional services” is narrower in the insuring provisions of the professional liability policy than in the exclusion in the CGL policy, a gap in coverage will likely result. Further, the definition in both policies should make clear the specific types of activities the insurer considers to be “professional services.” Disputes frequently arise when a company traditionally regarded as a service provider (like an architecture firm) performs work not traditionally regarded as “professional services” (like construction work under a design-build contract), and is later sued in a claim involving property damage or bodily injury. In the absence of a clear definition of “professional services,” the commercial general liability insurer will argue that the work was excluded “professional services” while the professional liability insurer will argue that the work was non-covered bodily injury or property damage, resulting in a gap in coverage for the policyholder.

2.  Nexus wording. 

Both CGL and professional liability insurers can alter the scope of coverage for a mixed risk by making seemingly imperceptible changes to the policy wording concerning the nexus required between two concepts, and the concepts between which there must be a nexus.

• The nexus required: The phrase “damages because of bodily injury or property damage arising from your professional services” is susceptible to being construed more broadly than “damages because of bodily injury or property damage caused by your professional services” because “caused by” is frequently considered to require a closer nexus to the loss than “arising from.”
• The concepts linked:  The phrase “damages because of bodily injury or property damage arising from your professional services” differs from “bodily injury or property damage that results in liability arising from your professional services” in that the former requires a connection between the “bodily injury or property damage” and the “professional services” rendered while the latter requires a connection between the “liability” and the “professional services.”

These slight differences can have a significant impact on the scope of coverage for a given claim. Oftentimes, liability is imposed on an insured even when the insured?s conduct giving rise to liability is remote from the actual cause of bodily injury or property damage (e.g., in strict liability or conspiracy claims). In these situations, an insuring agreement that requires a close nexus between the conduct of the insured (i.e., the professional services rendered) and the bodily injury or property damage might not be triggered. Conversely, an exclusion that provides for a broad nexus between the insured?s liability and the bodily injury or property damage can bar a broader scope of claims. In simpler terms, even a minute asymmetry in these provisions could result in purported gaps in coverage.

3.  Exclusions. 

Professional services exclusions in CGL policies, while common, are not a mandatory feature.  Insurers sometimes will agree to remove such an exclusion. If the carrier is unwilling to entirely remove the professional services exclusion, it may be amenable to issuing conditional limitations on coverage for claims involving “professional services,” such as provisions specifying that the commercial general liability policy is excess to or not applicable when coverage exists under the insured?s professional liability policy.

Some professional liability insurers include in their policies limitations or exclusions for bodily injury or property damage. Although these exclusions can be absolute, they most often reflect an attempt by professional liability insurers to merely ensure that the CGL carrier is assuming primary responsibility for general liability exposures like bodily injury and property damage. These limitations or exclusions should be avoided at all costs, unless the CGL carrier has clearly acknowledged that its policy covers mixed claims involving, on the one hand, bodily injury or property damage, and, on the other, professional services. That said, and all else being equal, it is generally better for mixed claims to be covered under CGL policies than professional liability policies as the market for the former typically has greater capacity at a lower price.

Monitoring Your Coverages

For the reasons highlighted above, it is imperative that companies consistently reassess the mix of their business activities and make sure their insurance matches that risk profile. As for those companies already aware of the risk of mixed professional and general liability claims, close attention should be paid to policy language to ensure that their coverage programs actually dovetail as intended. And, lastly, it is important to keep in mind that having the best coverage program in the world does no good if there is not an effective system for providing timely notice of claims to the appropriate carriers.

A Breach of Contract is Now an Element of Insurance Bad Faith Claims in Wisconsin

The Wisconsin Supreme Court held on June 14, 2011, in Brethorst v. Allstate, Case No. 2008AP2595, 2011 WI 41, that an insured can plead a bad faith claim against its insurer without pleading a separate breach of contract, as long as the breach of contract is alleged within the bad faith claim. Further, the Court specifically held an insurer’s “egregious” conduct alone towards its insured is insufficient to create coverage not otherwise existing under the policy.

Brethorst, the insured, suffered injuries from an auto accident and filed an insurance claim. After Allstate offered only a partial settlement of Brethorst’s claims and offered no factual grounds for its decision, Brethorst filed a bad faith claim. She did not, however, file an accompanying breach of contract claim seeking coverage. The lower court held an insured may maintain a bad faith claim without first proving a breach of contract claim as a condition precedent. The Supreme Court accepted the case for review.

The Court contrasted breach of contract claims from bad faith claims and held: (1) an insured may file a bad faith claim without also filing a breach of contract claim; (2) a breach of contract is a fundamental prerequisite to a bad faith claim against an insurer; and (3) an insured may not proceed with bad faith discovery without first satisfying the court that she has established such a breach or will be able to prove such a breach in the future.

Breach of Contract Claims versus Bad Faith Claims

The Court made clear that a breach of an insurance contract claim is merely the failure to pay the claim in accordance with the policy, while a bad faith claim constitutes, “a separate and intentional wrong, which results from a breach of duty imposed as a consequence of the relationship established by contract.” The Court held contract damages are not the result of bad faith acts, but of a breach of contract, and therefore should only be awarded in an improper denial of coverage. Second, allowing contract damages where no coverage is found would bind parties to conditions they did not contemplate or purchase, and therefore would be inconsistent with basic principles of contract law. Lastly, the Court recognized and warned that allowing bad faith claims completely separate from a prerequisite breach of contract, “would invite the filing of unmeritorious claims, focused on the insurer’s alleged misconduct.” Insurance claims, including bad faith, must be firmly anchored in contract law.

Pleadings versus Prerequisites

Importantly, the Court found that although a bad faith claim, “is a separate tort and may be brought without also bringing a breach of contract claim . . . bad faith cannot exist without some wrongful denial of benefit under the insurance contract.” An underlying breach of contract must be alleged, and the insured must plead that they were entitled to payment under the contract. The holding clarified that simply because a breach of contract need not be pleaded does not mean it need not exist, and concluded, “some breach of contract by an insurer is an fundamental prerequisite for a first-party bad faith claim against the insurer by the insured.”

Discovery on a bad faith claim

The Court limited the impact of its holdings by requiring an insured to plead breach of contract with her bad faith claim, and satisfy the court the breach can or will be proven in order to take discovery on bad faith claims. In essence, “an insured must plead, in part, that she was entitled to payment under the insurance contract and allege facts to show that her claim under the contract was not fairly debatable.” Only then may a plaintiff conduct discovery on bad faith topics such as claims handling procedures and internal coverage decision-making.

Implications of the Wisconsin Supreme Court’s Decision

The Court shifted away from its previous two-prong test for bad faith claims and adopted the three-prong test from Arnold Anderson’s treatise, Wisconsin Insurance Law. A bad faith claim in Wisconsin now must prove 1) the terms of the policy obligated the insurance company to pay the claim; 2) the insurer lacked a reasonable basis in law or fact for denying the claim; and 3) the insurer either knew there was no reasonable basis for denying the claim or acted with reckless disregard for whether such a basis existed. An insurer can defend against this claim either by showing there was no coverage under the policy and therefore no breach of contract, or by showing a reasonable basis existed for denying the payment or processing of the claim.

Although insureds may now bring a bad faith claim without a separate cause of action for coverage, coverage still must be alleged. In addition, a concurring opinion in the case points out the majority may have raised the pleading standards by now requiring an insured to, “allege facts to show that her claim under the contract was not fairly debatable,” and “plead facts which, if proven, would demonstrate . . . that the insurer breached its contract.” The concurring judge concluded that notice pleading was no longer sufficient in insurance bad faith cases.

Don’t Gamble with My Money: When a Lawsuit Seeks Damages in Excess of Policy Limits, What Are the Insured’s Rights in Illinois?

In general, if a lawsuit is covered or potentially covered by a commercial general liability (CGL) insurance policy, the insurer has a duty to defend that claim. If the insurer provides that defense without reserving its rights to deny coverage, the insurer is entitled to select defense counsel and control the defense. But when the insurer defends under a reservation of rights, that reservation may create a conflict of interest between the insurer and the insured.

The leading Illinois Supreme Court case on this subject is Maryland Casualty v. Peppers, decided in 1976. According to Peppers, when an insurer defends an insured, but reserves the right to deny coverage based on an exclusion in the insurance policy (the applicability of which could be established during the course of defending the insured), there is a conflict of interest that gives the insured the right to select independent counsel to defend it at the insurer’s expense. But the Illinois Supreme Court did not say that this is the only conflict of interest that could give rise to the insured’s right to select independent defense counsel.

In R.C. Wegman Construction Company v. Admiral Insurance Company, decided in 2011, the United States Court of Appeals for the Seventh Circuit answered a question that has vexed Illinois insureds for a long time. Although the case involves a relatively uncommon set of facts, the court’s ruling in Wegman recognizes the conflicting interests that can arise between insureds and insurers when an insured faces a claim in which there is a “non-trivial probability” that there could be a judgment in excess of policy limits.

The Nuts and Bolts of Wegman

R.C. Wegman Construction Company was the manager of a construction site at which another contractor’s employee was seriously injured. Wegman was an additional insured under a policy issued by Admiral Insurance to the other contractor. When the worker sued Wegman, Admiral acknowledged its duty to defend, apparently without reserving any rights, and undertook the control of Wegman’s defense. The Admiral policy provided $1 million in per-occurrence limits of liability. Although it soon became clear that there was a “realistic possibility” that the underlying lawsuit would result in a settlement or judgment in excess of the policy limits, Admiral never provided this information to Wegman.

Shortly before trial, a Wegman executive was chatting about the case with a relative who happened to be an attorney. That relative pointed out the risk of liability in excess of policy limits, and mentioned that it was important for Wegman to notify its excess insurers. But by then it was too late, and the excess insurer denied coverage because notice was untimely. A judgment was entered against Wegman for more than $2 million. Wegman sued Admiral for failing to give sufficient warning of the possibility of an excess judgment so that Wegman could give timely notice to its excess insurer. According to the Seventh Circuit, the key issue was whether this situation—in which there was a risk of judgment in excess of the limit of liability, and where the insurer was paying for and controlling the defense—gave rise to a conflict of interest.

Admiral’s explanation for failing to inform Wegman was ultimately part of its downfall. Because there were other defendants in the underlying lawsuit, there was a good chance that Wegman would not be held jointly liable and that if a jury determined that Wegman was no more than 25% responsible for the worker’s injury, Wegman’s liability would have been capped at 25% of the judgment. Admiral’s trial strategy was not to deny liability, but to downplay Wegman’s responsibility. Admiral, however, never mentioned this litigation gambit to Wegman!

In the Seventh Circuit’s view, this was a textbook example of “gambling with an insured’s money.” And that is a breach of an insurer’s fiduciary duty to its insured.

When a potential conflict of interest arises, the insurer has a duty to notify the insured, regardless of whether the potential conflict relates to a basis for denying coverage, a reservation of rights, or a disconnect between the available limits of coverage and the insured’s potential liability. Once the insured has been informed of the conflict of interest, the insured has the option of hiring a new lawyer whose loyalty will be exclusively to the insured. In reaching its Wegman conclusion, the Seventh Circuit cited the conflict-of-interest rule established by the Illinois Supreme Court’s Peppersdecision. Thus, a potential conflict of interest between an insured and an insurer concerning the conduct of defense is not limited to situations in which the insurer has reserved its rights.

In rejecting Admiral’s arguments, the Seventh Circuit explained that a conflict of interest (1) can arise in any number of situations and (2) does not necessarily mean that the conflicted party—the insurer—has engaged in actual harmful conduct. A conflict of interest that permits an insured to select independent counsel occurs whenever the interests of the insured and the insurer are divergent, which creates a potential for harmful conduct.

The conflict between Admiral and Wegman arose when Admiral learned that a judgment in excess of policy limits was a “non-trivial probability.” When confronted with a conflict of this type, the insurer must inform the insured as soon as possible in order to allow the insured to give timely notice to excess insurers, and to allow the insured to make an informed decision as to whether to select its own counsel or to continue with the defense provided by the insurer.

Looking Beyond Wegman

The fact pattern discussed in Wegman, however, is not the only situation in which there may be a conflict of interest between an insurer and an insured concerning the control of the defense. Under the supplemental duty to defend in a CGL policy, an insured is entitled to be defended until settlements or judgments have been paid out in an amount that equals or exceeds the limits of liability. The cost of defense does not erode the limits of liability, which means that the supplemental duty to defend is of significant economic value to an insured.

The following hypothetical situations (involving an insured covered by a CGL policy with $1 million in per-occurrence and aggregate limits of liability and a supplemental duty to defend) illustrate the economic value of the duty to defend:

• The insured is sued 25 times in one policy year. In each instance, the insurer acknowledges coverage and undertakes to defend the lawsuits. Each lawsuit is dismissed without the insured becoming liable for any settlements or judgments. The total cost of defending these 25 lawsuits is $1.5 million. The limits of liability are completely unimpaired with $1 million in limits of coverage remaining available.
• The insured is a defendant in dozens of lawsuits alleging that one of the products it sells has a defect that has caused bodily injury. The insurer agrees to defend. The lawsuits are consolidated, and the costs of defense accumulate to more than $2.5 million. Eventually, there is a global settlement of the lawsuits for $1 million. Thus, a total of $3.5 million has been paid out on an insurance policy with a $1 million limit of liability.
• The insured is involved in a catastrophic accident for which he was solely responsible and in which four other people were permanently disabled. Each of the victims files a lawsuit and the realistic projected liability exposure to each victim is $1.5 million—or $6 million collectively. Shortly after the complaints are filed (and before there has been any significant discovery or investigation), three of the plaintiffs make a joint offer to settle their claims for a collective $1 million. The insurer and the insured both believe that this is an outstanding settlement opportunity, but the fourth plaintiff wants her day in court. If the insured agrees to this promising settlement opportunity, the limits of liability will be exhausted, the duty to defend will be extinguished, and the insured will be forced to pay for his own defense or rely on his excess insurance to reimburse him for defense costs.

Any insured who has been in the position of defending against either a serious claim or a multitude of smaller claims will understand that the supplemental duty to defend under a CGL policy may have much greater economic value than the limit of liability alone.

In these kinds of situations—when either the potential liability exceeds policy limits or there are multiple claims against the insured such that the economic value of the defense is worth more than the limit of liability—who should be allowed to control the defense of claims against the insured? In prior cases (Conway v. County Casualty Insurance Company [1992] and American Service Insurance Company v. China Ocean Shipping Co. [2010]), Illinois courts concluded that an insurer cannot be excused of any further duty to defend by paying out its remaining limits to the plaintiffs or by depositing its policy limits into court. But this rule does not address the conflict of interest when (1) it is in the insurer’s financial interest to avoid the potentially unlimited expense of defending its insured but (2) it is in the insured’s interest to continue receiving a defense that may have greater financial value than the limits of liability of a primary CGL policy.

Thanks to the Wegman decision, there is now some authority acknowledging that the insured’s right to select independent counsel may exist even if the insurer defends without a reservation of rights. The court recognized that the insurer-insured relationship and the right to control the defense is fraught with potential conflicts. Therefore, it is more important than ever for insureds to protect their interests.

Federal Courts Block Key Provisions of Restrictive Immigration Laws in Georgia and Indiana

Today, a federal judge in Georgia granted a preliminary injunction against key provisions of the state’s immigration law, HB 87, which was slated to take effect Friday. Today’s decision follows another federal court decision handed down last week in Indiana which also blocked key provisions of the state’s new immigration law, SB 590. And these restrictive immigration laws aren’t the only ones caught up in legal battles. Several restrictive immigration laws are being challenged in court with more likely to follow. This week, the Department of Justice (DOJ) requested a meeting with Alabama law enforcement officials to determine whether or not to file suit against their immigration law while civil rights groups threatened to sue South Carolina if Gov. Nikki Haley signs their restrictive bill, S 20, into law.

U.S. District Judge Thomas Thrash, Jr. granted a preliminary injunction today temporarily enjoining two key provisions of the state’s restrictive immigration law, HB 87. In his decision, Judge Thrash argued that Georgia’s law “unlawfully interferes with federal power and authority over immigration matters.”

One provision of Georgia’s law would have made it a crime to “knowingly and willingly transport or harbor illegal immigrants while committing another crime.” The other provision would have authorized “Georgia law enforcement officers to investigate the immigration status of criminal suspects where the officer has probable cause to believe the suspect committed another criminal offense.” The section of Georgia’s law that requires businesses to check the immigration status of new hires, however, remains intact and is expected to be implemented July 1, 2011.

Georgia’s farming industry, meanwhile, is taking a hit as a result of HB 87 with reports of thousands of undocumented farm laborers fleeing the state. One survey estimates that there are already 11,080 vacant farm positions in Georgia that need to be filled. Georgia’s Agribusiness Council said farms have lost $300 million to date and could lose up to $1 billion if they can’t find reliable farm workers.

Last week, U.S. District Judge Sarah Evans Barker blocked two provisions of Indiana’s immigration law, SB 590. Describing the law as “seriously flawed,” Judge Evans found that the law violated the Constitution’s due process, search and seizure provisions and other protections. One provision would have allowed law enforcement to make warrantless arrests of those who have questionable immigration status—including those for whom DHS has issued a detainer or notice of action, which doesn’t necessarily mean they are unlawfully present. The other provision barred the use of consular identification cards as a valid form of ID. The ACLU and National Immigration Law Center (NILC) sued Indiana in May.

In Alabama this week, the DOJ is scheduled to meet with state law enforcement officials to determine whether not Alabama’s immigration law, HB 56, interferes with the federal government’s enforcement of immigration law. Alabama’s law requires local law enforcement to verify the immigration status of those stopped for traffic violations, public schools to determine the immigration status of students, employers to use E-Verify and makes it a crime to knowingly rent to, transport or harbor undocumented immigrants.

Despite the large costs and uphill legal battles in nearly every state that has passed Arizona-inspired immigration laws, some states, like South Carolina, continue attempts to put restrictive immigration laws on the books. Just this week, the ACLU and NILC announced plans to sue South Carolina if Governor Nikki Haley signs S 20, an immigration law which passed last week.

Sadly, the costs of these lawsuits is only one aspect of the numerous costs borne by states where SB 1070-style laws have passed. One can only hope that lawmakers’ appetites for restrictive immigration lawmaking will decrease as fallout continues.

Photo by zimmytws.