Facts vs. Labels and Potential for Amendment Govern in New York

Facts vs. Labels and Potential for Amendment Govern in New York

By David A. Gauntlett*

Introduction

In Tzumi Elecs. LLC v. Burlington Ins. Co.,[1] the Southern District of New York court concluded that all potentially covered claims arose out of the explicitly pled patent infringement causes of action in the underlying complaint.[2] Not so. That conclusion was unsupported by analysis explaining how the injury flowing from allegations of disparagement (the asserted basis for coverage) necessarily arose from the patent infringement. This decision inappropriately elevates the labels the plaintiff attached to the cause of action over the actual facts alleged. Further, it fails to account for the “potential for amendment” doctrine that has been accepted under New York law as well as inferences arising from the asserted fact allegations in light of the claimants’ potential intent to avoid triggering potential coverage.[3]

“Intellectual Property” Exclusion Did Not Apply in All Possible Worlds

The underlying complaint alleged that Tzumi had created an association between its products and those of Therabody, the underlying plaintiff. Therabody expressly alleged that Tzumi’s actions created a “negative effect on its reputation as innovator and pioneer” in its industry.[4] The court did not address the insured’s arguments that Tzumi’s advertisements sent a message placing Therabody and its products in a lesser light and thereby diminished Therabody’s standing as an innovator. By implication, “the value of the disparaged product was allegedly diminished.”[5] This inference is no greater than that courts have typically drawn under New York law.[6]

In Natural Organics, an analogous disparagement claim arose. There, it was held distinct from an intellectual property infringement claim because the court’s disparagement analysis featured elements not included in trademark infringement and indeed expressly excluded elements of trademark infringement. Similarly, patent infringement elements differ from those for disparagement.

A disparagement claim can arise from casting doubt on a party or its property without any intellectual property infringement. The court broadly construed the exclusion in contradiction of settled New York law.[7] The Tzumi Elecs. court, however, failed to appreciate how those differing elements preclude a conclusion that the disparagement injury “arose out of” the patent infringement claims. Only the elements of a complaint asserted as the basis for potential coverage are proper to consider when evaluating the applicability of an exclusion.[8]

Court Failed to Address Alleged Facts Rather Than Labels

It is of no moment that the Therabody Action did not allege a claim neatly labeled as “disparagement.” Nor that the indirect injury component of that form of disparagement was not highlighted in the underlying complaint. That absence does not affect the insurer’s duties. “A party’s characterization of the causes of action alleged . . . are not controlling . . . we . . . determine the nature of the claims based upon the facts alleged and not the conclusions which the pleader draws therefrom.”[9] New York courts have readily concluded that false advertising fact allegations may assert liability based on disparagement, requiring a defense, even without explicit statements disparaging a competitor.[10]

In the Therabody Action, it was expressly alleged that Tzumi’s advertising of similar products allegedly had a “negative effect on [Therabody’s] reputation as innovator and pioneer” and caused a “loss of first mover advantage.” These demonstrate a direct assertion of both disparagement and resulting injury, especially as “[t]he duty to defend does not require that that complaint allege or use language affirmatively bringing the claims within the scope of the policy.”[11] To the extent that the allegation is less than explicit, New York law has determined that disparagement can be found based on mere inferences so long as they are reasonably derived from the facts pled, as a federal district court in New York[12] concluded citing California law, which is consistent with New York law.

Potential for Amendment Triggered a Defense

Furthermore, the court failed to reconcile its decision with New York law’s requirement that a duty to defend determination must first consider the potential for amendment to the underlying complaint. This could have alleviated the court’s concern about the lack of explicitly pled disparagement claims. Requiring precision in fact assertions is contrary to settled New York law, which embraces liberal amendment rules to allow claimants to clarify and add allegations as litigation develops.[13] A statement that could reflect negatively upon competitors which looks to inferences and implied facts suffices.

In Ruder & Finn, Inc. v. Seaboard Sur. Co.,[14] the New York Court of Appeals explained why allegations that the insured “unfavorably and falsely desparaged [sic] ATI's aerosol products” sufficed.[15] It rejected Seaboard’s conclusion that “two solitary, unsubstantiated words” that were part of a “patently groundless and ‘shotgun allegation’ in the middle of . . . a completely unrelated federal antitrust cause of action which was, itself, undisputedly not covered” by Seaboard's policy could not possibly evoke a duty to defend.[16] It also rejected the trial court’s objection that “notably absent was any repetition, directly or indirectly, of the [relevant] allegation.”[17] Nor was it problematic that the fact allegations in Ruder & Finn were “couched in terms of restraint of trade.”[18]

Conclusion

The policyholder safeguards required by New York law are no help in coverage disputes if judges refuse to apply them. This narrow construction is evidenced by a recent pattern in federal coverage decisions.[19] The Waller principle of limiting exclusion evaluation to the asserted basis for coverage, the requirement of addressing only alleged facts rather than labels, and the “potential for amendment” doctrine have all been embraced by New York state judges. Their federal counterparts, however, appear less disposed to apply these aspects of New York law that support policyholders’ rights.

*David A. Gauntlett is a principal of Gauntlett & Associates and represents policyholders in insurance coverage disputes regarding intellectual property, antitrust, and business tort claims, as well as in the underlying actions. Mr. Gauntlett can be reached at (949) 553-1010 by voicemail or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[1] No. 22-CV-10307 (JMF), 2023 WL 4931656, (S.D.N.Y. Aug. 2, 2023); see David A. Gauntlett, Insurance Coverage of Intellectual Property Assets, 2d ed., Ch. 3 (2023) for further analysis of this and similar cases.

[2] Id. at *4.

[3] Hudson Ins. Co. v. Colony Ins. Co., 624 F.3d 1264, 1269 (9th Cir. 2010) (“The technical label on a cause of action does not dictate the duty to defend whether the claimed cause of action was omitted out of negligence or ‘for strategic adversarial reasons.’”)

[4] Id. at *2.

[5] Nat. Organics, 959 N.Y.S.2d at 208.

[6] Lexington Ins. Co. v. MGA Entm't, Inc., 961 F. Supp. 2d 536, 550 (S.D.N.Y. 2013) (“[A] court will consider facts fairly inferable from — and potential amendment to — the underlying complaint[.]”)

[7] Schlather, Stumbar, Parks & Salk, LLP v. OneBeacon Ins. Co., 2011 U.S. Dist. LEXIS 147931 at *19-20 (N.D.N.Y. Dec. 22, 2011) (“[T]his term [‘arising our of’] ‘should be interpreted as narrowly as possible in an insurance exclusion, because any ambiguities in insurance contracts should be resolved in favor of the insured.’”) (quoting Gluck v. Executive Risk Indem., Inc., 680 F. Supp. 2d 406, 419 (E.D.N.Y. 2010)) (emphasis added).

[8] Allied Prop. & Cas. Ins. Co. v. Matthews, No. 16-cv-680 (DAB), 2018 U.S. Dist. LEXIS 52083, *18–19 (S.D.N.Y. Mar. 20, 2018) (Concluding no conflict arose as between New York and California law re applicability of an exclusion even if potential coverage arose) (citing Waller v. Truck Ins. Exch., 11 Cal. 4th 1, 16 (1995) (“Before ‘even considering exclusions, a court must examine the coverage provisions to determine whether a claim falls within [the policy terms].’”)

[9] Syvertsen v. Great Am. Ins. Co., 700 N.Y.S.2d 289, 291–92 (N.Y. App. Div. 1999 (quotations omitted).

[10] Bridge Metal Indus., LLC v. Travelers Indem. Co., 559 F. App'x 15, 19 (2d Cir. (N.Y.) 2014) (“National's New York action also contains specific counts alleging that Bridge Metal's conduct constituted ‘false advertising.’ The advertising and marketing of Bridge Metal's products constituted at least a part of the harm that National allegedly suffered, and thus, the district court correctly concluded that the underlying actions alleged advertising injury.”)

[11] Axiom Ins. Managers, LLC v. Capitol Spec. Ins. Corp., 876 F. Supp. 2d 1005, 1013 (N.D. Ill. (E.D.) 2012).

[12] Dollar Phone Corp. v. St. Paul Fire & Marine Ins. Co., No. CV-09-1640 (DLI) (VVP), 2012 U.S. Dist. LEXIS 45591, *24 (E.D.N.Y. Mar. 9, 2012), report and recommendation adopted, 09-CV-1640 DLI VVP, 2012 U.S. Dist. LEXIS 45652 (E.D.N.Y. Mar. 30, 2012) (“This does not necessarily mean that the competitor's product must be identified by name and it may be enough that there be some identifying statement that compares the advertised product to those sold by competitors. See, e.g. Acme, 214 Fed. Appx. at 599-600 (advertisements stating that insured's titanium products were ‘sharper, more durable, and longer lasting’ drew sufficient comparison to plaintiff's steel products).”)

[13] See David A. Gauntlett, Coverage Based on Potential for Amendment of Underlying Pleadings, https://www.gauntlettlaw.com/news/ltstlvxs1vwlifa3rni6btlbkoqkap (Sep. 3, 2023).

[14] 52 N.Y.2d 663 (1981).

[15] Id. at 669.

[16] CNA Cas. of Cal. v. Seaboard Sur. Co., 176 Cal. App. 3d 598, 612 (1986) (addressing facts from Ruder & Finn).

[17] Ruder & Finn, 52 N.Y.2d at 668.

[18] Id.

[19] See David A. Gauntlett, Coverage Based on Potential for Amendment of Underlying Pleadings, https://www.gauntlettlaw.com/news/ltstlvxs1vwlifa3rni6btlbkoqkap (Sep. 3, 2023); David. A. Gauntlett, New York District Court Disputes Whether Settlements Clarify Potential Coverage, https://www.gauntlettlaw.com/news/new-york-district-court-disputes-whether-settlements-clarify-potential-coverage (Feb. 1, 2024).