Daily Archives: March 22, 2011

Coverage Tips: Insured Versus Insured Exclusions

Virtually all D&O insurance policies contain an Insured versus Insured (“I v. I”) exclusion. A typical I v. I exclusion provides that the policy does not cover loss resulting from any claim made against any insured . . . “brought or maintained by or on behalf of any Insured or Company in any capacity.” It is well accepted that I v. I exclusions are intended to exclude coverage for collusive suits, such as those brought by the company against its own directors or officers to recover losses resulting from poor business decisions. In certain situations, however, a court may find that an I v. I exclusion bars coverage for a claim that most policyholders would have assumed was covered. The following are examples of how an I v. I exclusion may unexpectedly result in a coverage gap:

(1) Where a shareholder suit is brought against insured directors and officers by numerous plaintiffs, one or more of whom qualifies as an insured person, a court may find that the I v. I exclusion bars coverage for the entire suit.

In other words, a court may find that the I v. I exclusion bars coverage for claims brought by noninsureds if they are brought in the same suit as claims by insured persons. To avoid this situation, policyholders should request a policy amendment stating that the I v. I exclusion does not apply to claims brought by noninsured persons or entities, even if brought in the same suit as claims by insured persons or entities, or similar wording.

(2) A common exception to the I v. I exclusion is a claim brought in any bankruptcy proceeding by the examiner, trustee, receiver, liquidator, rehabilitator or similar official of the company.

A court may find that the bankruptcy exception does not, however, apply to claims brought by examiners, trustees, receivers, liquidators, rehabilitators or similar officials of companies whose insolvencies are not governed by the U.S. Bankruptcy Code, including insurance companies, banks and other deposit institutions, and other financial institutions that are regulated by federal and state government. Policyholders in these industries should make sure that their “bankruptcy exception” extends to any type of insolvency proceeding, and not solely to insolvency proceedings governed by the U.S. Bankruptcy Code.

(3) The Dodd-Frank Act provides new incentive for whistleblowers who may qualify as insured persons. A court may find that, where the whistleblower is an insured person, the I v. I exclusion bars coverage for the whistleblower claim.

To avoid this potential coverage gap, policyholders should request an exception to the I v. I exclusion for whistleblower actions. To the extent a policyholder already has such an exception in its policy, it should make sure that the exception is broad enough to apply to all types of whistleblower actions, and not only those brought under Sarbanes-Oxley.

Employment Practices Liability Insurance: The Benefits and Pitfalls

Many insurance companies offer what is known as employment practices liability insurance (EPLI). The purpose of an EPLI policy is to protect your business against the risk of heavy financial losses resulting from employment claims. Before purchasing such a policy, however, you should know that it is not a silver bullet. Employers often do not learn until a claim already has been made and the policy is being invoked what some of the drawbacks and shortcomings of EPLI coverage tend to be.

What Is and Isn’t Covered

Typically, EPLI provides coverage to the employer, its executives and its employees against claims for employment discrimination, retaliation and harassment; claims for defamation, invasion of privacy and negligent supervision arising in the employment context; and claims for wrongful discharge, failure to promote and failure to hire.

However, EPLI typically will not cover claims by employees to enforce rights under the Fair Labor Standards Act (wage and hour claims), ERISA (employee benefits claims), the WARN Act (requiring certain employers to provide advance notice of plant closings and mass employee layoffs), COBRA, the National Labor Relations Act, and the Occupational Health and Safety Act regulations, as well as the state statute equivalents of each of these federal statutes. Additionally, EPLI typically does not cover the costs associated with providing a “reasonable accommodation” under the Americans with Disabilities Act (ADA), and it may not cover certain types of claims for breach of employment contract or claims by independent contractors.

These exclusions can be significant for employers. In fact, claims falling under some of these statutes or theories are increasingly common and can carry considerable exposure, including potential class claims and claims for punitive damages. This is particularly true of wage and hour claims. For example, if an employee or group of employees claim they were improperly classified as exempt, they can bring a class action lawsuit for all overtime pay for work the putative class performed in excess of 40 hours in a workweek. For an employer, this can lead to significant potential liability for back pay, liquidated damages and plaintiffs’ attorneys’ fees. Yet such claims likely would not be covered under EPLI.

Similarly, affirmative claims you may want to bring against employees who sue you may not be covered. So if an employee sues you for discrimination and you want to file a counterclaim for misappropriation of trade secrets, breach of duty of loyalty or breach of restrictive covenant, your EPLI may not cover the cost of pursuing those claims.

Punitive damages also generally are not covered.

Defense Costs and Selection of Counsel

Attorneys’ fees and other defense costs are usually included within the limits of an EPLI policy. Since legal fees often represent the largest expense to an employer in dealing with covered claims, this is generally a beneficial feature. However, every dollar spent by the carrier defending a claim erodes the amount available to pay for a judgment or a settlement. Also, the existence of insurance coverage must be disclosed as part of discovery in most lawsuits. Once a plaintiff’s attorney has this information, he or she may hold out for more money in settlement.

Employers should be aware that the defense cost feature of an EPLI policy usually also allows the carrier to control selection of counsel and influence case-handling strategy. This can have significant repercussions when it comes to settling a case. From the employer’s standpoint, there is the concern that any settlement amount greater than nuisance value may encourage other employees to also sue. The insurer, however, may view an employment claim the same as other insurance claims and focus predominantly on the potential for liability and the amount of damages.

Some EPLI policies address the potential for a disagreement over settlement either by giving the insurer the right to settle without the employer’s approval or, as is perhaps more often the case, by giving the employer control over settlement while adding a “hammer clause.” Such a clause provides that if the policyholder refuses to accept an offer to settle a claim that the insurer is willing to accept, then the insurer will not be liable for a subsequent settlement or judgment in excess of the rejected settlement amount.

Policy Limits and Deductibles

Typically, EPLI policy limits and deductibles apply on a per claim and aggregate basis. For example, a policy may limit coverage to $250,000 for each separate claim with an aggregate cap of $1 million for all claims. In setting deductibles and limits, you should determine your comfort level. If you view EPLI as a type of catastrophic coverage for employment claims, you may want to negotiate higher deductibles that essentially leave you uncovered for smaller claims.

Policy Type, Insurer Notification and Other Factors to Consider

EPLI policies typically are written on a “claims made” basis, meaning the claim must be incurred during the coverage period and the insurer must be notified during a designated reporting period. Untimely notice to an insurer can provide a basis to reject coverage for an otherwise covered employment claim.

Employment disputes sometimes take a long time to develop into claims. Therefore, you should consider purchasing tail coverage if or when the primary EPLI policy is dropped.

There are other factors to consider in purchasing an EPLI policy. For example. insurers usually require you to select from an approved “panel” of attorneys for your defense. If you have an existing relationship with an attorney with whom you are comfortable, however, you should request that the insurer allow you to choose your own defense counsel.

EPLI is definitely not for everyone. Before you buy a policy, you should be aware of the many pros and cons, and understand what EPLI will and will not do for you.

Three Key Things Employers and Employees Should Know about Social Media

No company today can turn a blind eye to the social media explosion. Facebook alone claims more than 500 million active users worldwide, while the more business-oriented LinkedIn has more than 90 million members in 200-plus countries and territories. With this kind of reach, the social media phenomenon is clearly here to stay. Amid this new world order, there are three key things that employers and their employees should keep in mind.

1: Think Twice before “Friending” Your Boss or Subordinates on Facebook

A recent situation involving the Honorable Susan Criss, a circuit court judge in Galveston, Texas, provides a cautionary tale of what can happen when you start “friending” the wrong people on Facebook. An attorney who accepted a “friend” request from Judge Criss subsequently filed a motion to continue a trial due to her father’s death. Judge Criss granted the attorney’s motion but watched her Facebook activity that week. Rather than quietly grieve her loss, the attorney posted comments and uploaded photos that depicted her partying throughout the week. When a colleague sought a second continuance at the attorney’s request, Judge Criss showed him the Facebook activity and ultimately denied the motion. The attorney was subsequently reprimanded.

2: Who Wants Employees Who Tweet Their Personal Gripes about the Company?

In November 2010, the National Labor Relations Board (NLRB) brought a complaint against American Medical Response (AMR) for allegedly violating the National Labor Relations Act (NLRA). The NLRB claimed that AMR fired an employee who used Facebook to allegedly engage in “concerted activity.”

AMR denied that the discharged employee’s Facebook posts had anything to do with collective action relating to the terms and conditions of employment. AMR maintained that the fired employee violated its social media policy by using profanity and disparaging her supervisor on Facebook. For example, she posted that her supervisor was a “scumbag” and a “17,” the company’s jargon for a psychiatric patient.

Although the case settled in early 2011, there are lessons to be learned for both employers and employees.

Employers: Employers generally understand that the NLRA protects the rights of employees to unionize. However, many do not know that the NLRA also protects the rights of employees to engage in “concerted activities for the purpose of…other mutual aid or protection,” even when they are not union members. While we wait for courts to weigh in on exactly what is protected concerted activity in the social media context, companies should have counsel draft or review their social media policies to ensure they do not overreach and prohibit or chill protected concerted activity.

Employees: Employees should realize that few companies want to hire or retain individuals who exhibit poor judgment by using social media to publicly gripe about their employers. Even if you use the most stringent privacy settings on your Facebook profile, it is unlikely that all of your “friends” will keep your comments a secret. Furthermore, common sense dictates that many of them have little or no privacy protections of their own, which means the general public may be able to read at least some of what you post. While expressing your anger publicly may feel good in the heat of the moment, smart employees should think twice before posting or tweeting. Otherwise, you may run the risk of a current or prospective employer viewing you in the same camp as Charlie Sheen and Courtney Love.

3: You Need a Social Media Policy

Employers: If your company does not yet have a social media policy, it’s time to implement one. The purpose?

  1. To identify who may initiate social media activities on behalf of your company. For example, can any employee post, blog or tweet on the company’s behalf? Does the company want to exert tighter control by designating a committee or department to oversee the way it uses social media?
  2. To discipline or discharge employees when they violate the company’s social media policy.
  3. To avoid ex-employee lawsuits like Pietrylo v. Hillstone Restaurant Group.
  4. To set forth the company’s rules on using social media at work or at home (if an employee’s personal posts or tweets are work-related). For example, do you want your policy to do one or more of the following:
    • Encourage employee use of social media outlets to circulate promotions or quickly respond to customer complaints and problems? Or, at the other extreme, ban the use of social media at work or during working hours?
    • Prohibit employees from commenting publicly on the company’s products, clients or competitors? Or, if commenting is allowed, require employees to get advance approval or limit their comments to an internal intranet for training or product feedback?
    • Direct employees to refrain from creating a blog or online group related to their jobs? If allowed, require a disclaimer that the employees’ opinions do not reflect those of the company?
    • Prohibit defamatory or disparaging posts? (Think Charlie Sheen or Courtney Love, who recently settled a defamation claim to the tune of $430,000 for her disparaging tweets about fashion designer Dawn Simorangkir).
    • Prohibit retaliation in response to negative posts about the company, co-workers or themselves?
    • Direct employees not to use the company’s logo or marks in a social media context?

Employees: Read your company’s social media policy so that you know your employer’s stance on using social media during working hours, as well as what uses require prior approval. Understand how you can best use social media to support your employer’s business objectives, thus potentially helping yourself advance within the company. Understand that if you access personal e-mail or social networking sites on company equipment, you have implicitly authorized your employer to access that content as part of its normal systems monitoring. In short, know what you can and cannot do under the policy, along with the consequences of a violation.

The Year 2010 In Review: Contractor Licensing

1. Loranger v. Jones, 184 Cal. App. 4th 847 (3d Dist. May 2010)

Jones, a licensed contractor, had a workers’ compensation policy covering his employees. Jones unknowingly used an unlicensed subcontractor and knowingly permitted two minors without work permits, and another person without a contractor’s license, to help perform work for Loranger. Loranger refused to pay the final invoice and Jones filed suit for breach of contract. Loranger cross-complained alleging defects and sought disgorgement of monies paid.

However, the Court of Appeal, affirming the trial court, held that Jones’ license had not been automatically suspended under Business and Professions Code Section 7125.2 and accordingly, Jones was not subject to the sanctions of Section 7031 subdivisions (a) and (b). Loranger largely relied upon Wright v. Issak, 149 Cal. App. 4th 1116 (6th Dist. 2007) in arguing that Jones could not bring suit and was subject to disgorgement. However, the Court found Wright distinguishable because in that case the contractor intentionally reported zero payroll to avoid obtaining workers’ compensation insurance. In the instant case, however, Jones had workers’ compensation coverage when he began the project. At worst there may have been a lapse of coverage; however, without notice of a lapse of coverage from the registrar, there was no effective suspension of the contractor’s license. The Court also expressly rejected a reading of Wrightto find “any” underreporting of payroll tantamount to a failure to obtain workers’ compensation coverage and thus an automatic suspension of a contractor’s license.

2. In re Yehuda Sabban, 600 F.3d 1219 (9th Cir. BAP, April 2010)

A homeowner won a judgment against an unlicensed contractor under Business and Professions Code Sections 7031(b) (disgorgement for non-licensure) and 7160 (contract induced by falsity or fraud) in state court. After the trial, the contractor filed for bankruptcy under Chapter 7 of the Bankruptcy Code (liquidation of all non-exempt personal property to pay off creditors). The individual filed an adversary action to determine the dischargeability of the debt. He argued that both awards imposed a remedy for violations of statutes punishing the contractor for debts obtained by fraud and therefore, pursuant to 11 U.S.C. § 523(a)(2)(A), those debts were not dischargeable. The bankruptcy court partially rejected that argument, holding that the 7031(b) award was dischargeable and finding the smaller award under 7160 was non-dischargeable. The Ninth Circuit, in affirming the bankruptcy court ruling, held that the 7031(b) award was not traceable to fraud, and was not premised on fraud, and so it was dischargeable. Thus, an award against an unlicensed contractor under Business and Professions Code Section 7031(b) is dischargeable in bankruptcy.

3. Alatriste v. Cesar’s Exterior Designs, Inc., 183 Cal. App. 4th 656 (4th Dist. April 2010)

A homeowner employed a landscaping contractor which it knew did not have a contractor’s license at commencement of work. The contractor stopped work when the homeowner refused to make payments. The homeowner brought suit to recover the money he had already paid to the contractor. The contractor contended that the homeowner’s claim was barred because he knew about the contractor’s unlicensed status.

The Court of Appeal rejected the contractor’s argument, stating that Business and Professions Code Section 7031(a) provides a complete defense to a claim for payment from an unlicensed contractor, even when the customer knew the contractor was unlicensed. The Court applied that rationale to the “sword provision” of 7031(b), holding that knowledge of unlicensed status does not provide a defense to a claim for disgorgement of payments made for unlicensed work. Furthermore, the Court rejected the contractor’s argument that it was entitled to retain payment for work performed after it obtained a license, noting that 7031(b) provides for disgorgement if a contractor was unlicensed at any time during the performance of work. The homeowner was entitled to recover the total amount paid, including payment for materials.

4. UDC-Universal Development, L.P. v. CH2M Hill, 181 Cal. App. 4th 10 (6th Dist. Jan. 2010), rev. denied, 2010 Cal. LEXIS 4141

UDC-Universal Development, L.P. entered into two contracts with CH2M Hill, pursuant to which CH2M agreed to provide engineering and environmental planning services for UDC’s condominium development. The contracts included an indemnity provision that covered all of UDC’s losses to the extent that they arose from, or were connected to, any negligence or omission by CH2M. A duty to defend clause obligated CH2M to defend any suit, action or demand brought against UDC on any claim “covered herein” upon written request from UDC. After completion of the development, the homeowners association brought suit against UDC for “defective conditions” due in part to negligence attributable to CH2M. CH2M rejected UDC’s tender of defense, and UDC cross-complained against CH2M for indemnity.

CH2M argued that UDC’s indemnity claim was barred because UDC lacked a contractor’s license when it entered into the contracts. However, the Court of Appeal held that the term “compensation” as used within Business and Professions Code Section 7031(a) means sums claimed as an agreed price or fee earned by performance, and not indemnification for claims related to a subcontractor’s work. Accordingly, the Section 7031(a) bar on actions to recover compensation for work performed by an unlicensed contractor does not apply where the contractor is seeking indemnity for damages paid as a result of a subcontractor’s defective work. Regardless of whether a developer is properly licensed, where a contract imposes on a subcontractor a duty to defend against any claim implicating the subcontractor’s work, the duty arises as soon as a defense is tendered.

5. Licensing Now Available to LLCs (SB 392)

Effective January 1, 2011, section 7025 of the Business & Professions Code is amended to allow limited liability companies to obtain contractor licenses in California. The License Board is required to begin processing applications therefor not later than January 1, 2012. In order for an LLC to hold a license, it must file and maintain a surety bond in the amount of $100,000 for the benefit of employees to ensure payment of wages and fringe benefits (in addition to the contractor’s license bond required of all licensees.) Further, if the LLC is a signatory to a collective bargaining agreement, the new bond must cover fringe benefit trust fund contributions. Finally, a licensed LLC must maintain and furnish proof of specified insurance coverage in an amount between $1-5M, depending on the number of personnel of record.