Coverage Based on Potential for Amendment of Underlying Pleadings

Coverage Based on Potential for Amendment of Underlying Pleadings

By David A. Gauntlett*

Introduction

Policyholders and even general counsel often overlook the potential for coverage by only considering the causes of action in a Complaint. In truth, it is the factual allegations that govern, not the labeled causes of action.[1] And in many jurisdictions, the original form of a Complaint is only the starting point, as insurers must consider the potential for clarifying amendments that would nudge the allegations of a poorly drafted Complaint to within the scope of potential coverage.[2]

Majority Rule – Potential Amendments Must Be Considered

Most states have expressly adopted the policy that insurers must consider the potential for amendment when determining whether a Complaint implicates its duty to defend.[3] For example, the California Supreme Court has stated:

[T]hat the precise causes of action pled by the third party complaint may fall outside policy coverage does not excuse the duty to defend where, under the facts alleged, reasonably inferable, or otherwise known, the complaint could fairly be amended to state a covered liability.[4]

As an illustrative example, CNA Cas. of Cal. v. Seaboard Sur. Co.[5] featured an underlying antitrust complaint against the policyholder, and the insurer argued there was reasonable expectation of coverage under any of the subject policies. The court disagreed. It acknowledged that, at the time of the insurer’s denial, the Complaint featured no express causes of action that would implicate potential coverage. However, the court quickly followed by noting that the insurer “had no grounds for concluding that the [underlying] lawsuit was ‘incapable of amendment’ to set forth explicit causes of action for malicious prosecution, libel, slander, defamation, disparagement, trade ‘piracy,’ unfair competition, or idea misappropriation[,]” any one of which would have triggered a duty to defend.[6]

Similarly, Safeguard Scientifics v. Liberty Mut. Ins. Co.,[7] considered both Pennsylvania and New York law as applied to an underlying Complaint that explicitly alleged intentional defamation. Because intentional conduct was excluded from coverage, the insurer denied its duty to defend. Despite alleging only intentional conduct, the underlying Plaintiff never produced conclusive evidence of intent, leading the “judge in the underlying case [to] correctly determine[] that this claim was viable if the slander was reckless or negligent.”[8] The coverage case opinion noted that New York’s liberal amendment rules would easily allow the pleadings to be corrected to have the asserted scienter match the evidence, meaning there was a potential for claims covered by the policy.[9]

Minority Rule – Potential Amendments May Be Ignored

Not all states agree with the approach described above. Like the Safeguard case above, Ledford v. Gutoski[10] featured express allegations that the policyholder subjectively intended to cause harm through malicious prosecution.[11] The policyholder argued in the appellate trial that malicious prosecution could be sustained without a determination of intent,[12] but the appellate court disagreed, holding that harm caused by malicious prosecution was inherently intentional. The Oregon Supreme Court agreed with the appellate court’s conclusion but not its analysis.

In analyzing the duty to defend, a court's focus should be on the conduct alleged in the complaint. . . . The Ledford complaint did not allege, and without amendment would not permit proof, that Kuhl instituted the criminal action against Ledford for some “malicious” purpose other than to “harass, annoy, harm and cause expense to” Ledford. Because the complaint alleged only that Kuhl subjectively intended to harm or injure Ledford, it is irrelevant whether or not a claim for malicious prosecution could, in theory, be sustained where the defendant did not have a subjective intent to cause harm or injury to the plaintiff.[13]

The common justification for this narrower view of the duty to defend is that it gives the insurer greater certainty in its decisions for whether it must defend a claim.[14]

Unfortunately, Judges Make Mistakes

Even in states that theoretically embrace an expanded duty to defend that extends to possible amendments of a Complaint, judges often focus too strongly on those claims actually asserted. A recent example of this can be seen in Tzumi Innovations LLC v. Twin City Fire Ins. Co.[15] In this case, the underlying class action suit was instituted by consumers who had purchased cleaning products that did not have the EPA certifications to justify the statements on their packaging.[16]

Potential coverage should have been found due to the implicit disparagement of competitors, which was evidenced in the underlying Complaint by allegations made under Mass. Gen. Laws Ch. 93A, § 2[17] and “California Civil Code §1750, et seq.”[18] Both of these statutes enable consumers to sue a company that disparages its competitors under the theory that such disparagement, while not directly attacking consumers, nonetheless harms them by muddying the waters of the marketplace.[19] Despite these allegations and the clear pathway for amendment to include an express disparagement claim, the court found no potential coverage, dismissing the claims under the Massachusetts statute as unsupported and entirely ignoring the claims under the California statute.[20]

Conclusion

Determining whether potential coverage arises based on the allegations of a Complaint is no easy task. As noted above, not even judges are immune to errors in such an endeavor, much less an insurance worker who has been instructed on every possible justification and given every possible incentive to deny the claims that land on their desk. For this reason, a denial should not be viewed as a conclusive assessment of a claim’s merits. Instead, expert coverage counsel should be consulted to determine whether the insurer has misjudged the scope of potential coverage.

*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) 514-5662 or dag@gauntlettlaw.com. For more information, visit Gauntlett & Associates at www.gauntlettlaw.com.

[1] Atlantic Mut. Ins. Co. v. J. Lamb, Inc.,, 100 Cal. App. 4th 1017, 1034 (2002) (“The scope of the duty does not depend on the labels given to the causes of action in the third party complaint; instead it rests on whether the alleged facts or known extrinsic facts reveal a possibility that the claim may be covered by the policy.”) (emphasis in original).

[2] Ruder & Finn Inc. v. Seaboard Sur. Co., 52 N.Y.2d 663, 669–70 (N.Y. 1981) (“[A] policy protects against poorly or incompletely pleaded cases as well as those artfully drafted.  . . . If, liberally construed, the claim is within the embrace of the policy, the insurer must come forward to defend its insured no matter how groundless, false or baseless the suit may be.”)

[3] For a full list with case citations, see David A. Gauntlett, Insurance Coverage of Intellectual Property Assets Appendix P (2d ed. 2023).

[4] Scottsdale Ins. Co. v. MV Transp., 36 Cal. 4th 643, 654(2005).

[5] CNA Cas. of Cal. v. Seaboard Sur. Co., 176 Cal. App. 3d 598 (1986).

[6] Id. at 610.

[7] Safeguard Scientifics v. Liberty Mut. Ins. Co., 766 F. Supp. 324 (E.D. Pa. 1991).

[8] Id. at 329.

[9] Id. at 330.

[10] Ledford v. Gutoski, 319 Or. 397 (1994).

[11] Id. at 402.

[12] Id.

[13] Id. at 402–03.

[14] See, e.g., Ferguson v. Birmingham Fire Ins. Co., 254 Or. 496, 505–06 (1969) (“The insurer's knowledge of facts not alleged in the complaint is irrelevant in determining the existence of the duty to defend and consequently the insurer need not speculate as to what the ‘actual facts’ of the alleged occurrence may be.”)

[15] Tzumi Innovations LLC v. Twin City Fire Ins. Co., No. 22-CV-10004 (RA), 2023 U.S. Dist. LEXIS 141877 (S.D.N.Y. Aug. 11, 2023).

[16] Id. at *3–4.

[17] This statute imposes liability for “[d]isparaging the goods, services, or business of another by false or misleading representation of fact.”

[18] The “et seq.” abbreviation means “and the following.” The cited portion of the California Civil Code runs from Section 1750 to 1785, thereby including Section 1770(a)(8), which also imposes liability for “[d]isparaging the goods, services, or business of another by false or misleading representation of fact.”

[19] See Miller v. Ghirardelli Chocolate Co., No. C 12-04936 LB, 2013 U.S. Dist. LEXIS 49733, *15–16 (N.D. Cal. Apr. 5, 2013) (consumer claims for disparagement were asserted pursuant to California Civil Code § 1770(a)(8) for marketing of products as “chocolate” leading “customers to falsely believe that the baking chips were (or contained) chocolate, white chocolate and/or . . . cocoa butter.”)

[20] Tzumi Innovations LLC v. Twin City Fire Ins. Co., 2023 U.S. Dist. LEXIS 141877 at *11, n.4.