New York District Court Disputes Whether Settlements Clarify Potential Coverage
/New York District Court Disputes Whether Settlements Clarify Potential Coverage
By David A. Gauntlett*
Introduction
A recent Southern District of New York decision deviates from New York coverage law principles. Therein, the court decided that recitals in a Settlement Agreement which the insurer evaluated and concluded did not trigger a defense before the settlement was consummated did not clarify whether the underlying action implicated potential coverage. This continues a problematic trend in New York federal court decisions that have interpreted an insurer’s duty to defend more narrowly than their state counterparts, which the federal courts are bound to follow.
Settlement Agreement Clarified Potential Disparagement Liability
In Tzumi Electronics, LLC v. The Burlington Insurance Company,[1] district Judge Failla determined that a lawsuit resolved by a Settlement Agreement, executed by the underlying plaintiffs, did not require a defense. This despite its explicit characterization of the complaint as “alleging . . . [that the insured’s] implicit disparagement of its competitors” did not trigger the insurer’s duty to defend for allegations of “‘[p]ersonal and advertising injury’ . . . arising out of . . . [o]ral or written publication, in any manner, of material that . . . disparages a person’s or organization’s goods, products, or services.”[2] This decision did not explain why the Settlement Agreement was not actionable “extrinsic evidence” like that in a Pre-Trial Conference Order in which this claim would have been included had the case proceeded to trial[3] as it “supersedes the pleadings” as a matter of law under the Rule 16(e) of the Federal Rules of Civil Procedure.[4]
In the underlying action, the insured was accused of overstating the capacity of power banks it sold. The Settlement Agreement, submitted to Burlington for review before it was fully executed, acknowledged disparagement liability that would trigger a defense under its policy for indirect injury made expressly actionable under Cal. Civ. Code Section 1770(a)(8) which provided express standing to consumers injured by the defendants’ implicit as well as direct negative comparative statements about its competitors.[5] It stated:
[T]he pricing of Tzumi’s power products made them appear much more affordable than competitors’ similar products that are not claimed to be deceptively labeled[.]
[C]onsumers of portable power bank devices prefer higher charging capacity at lower prices[.]
Plaintiffs’ theories of the case include that Tzumi’s portable power bank products enjoyed commercial success because they appeared to have more charging power for PEDs at lower prices than competing products[.]
The court failed to recognize that Settlement Agreement recitals (subject to insurer analysis and review before the settlement consummation) are indistinguishable evidence of the facts in controversy from interrogatory requests expanding the scope of issues embraced by claims asserted against a defendant.[6] As the Second Circuit’s High Point decision emphasized, any articulation of a claim by the party suing the insured are germane to coverage analysis, even if the form in which they are presented is not a Complaint. In light of this analysis, the Settlement Agreement is a form of “extrinsic evidence” germane to interpreting the duty to defend.[7]
The court’s lack of analysis resulted in a string of legal conclusions untethered to any cogent coverage analysis.[8] Notably, the Tzumi Electronics court also failed to address First One Lending Corp. v. Hartford Cas. Ins. Co., a case brought to its attention in which potential coverage for disparagement was reinforced by the contents of a Settlement Agreement.[9] No explanation is provided as to why the Settlement Agreement is not similar to “‘judicial admissions in . . . formal submissions in the current or underlying litigation to confirm or clarify the nature of the underlying claims’” in order to defeat potential coverage.[10] “Extrinsic evidence” may expand the scope of potentially covered claims.[11] A Settlement Agreement fulfills exactly that purpose—“confirm[ing] or clarify[ing] the nature of the underlying claims.”.
The District Court Failed to Consider the Potential for Amendment
Expecting a requirement of precision in fact assertions contrary to settled New York law, the district court determined that the Settlement Agreement was insufficient because it did not “introduce any new factual allegations containing specific misstatements or misrepresentations that Tzumi made regarding its competitors . . . .”[12] A statement that could reflect negatively upon competitors which looks to inferences and implied facts suffices.[13] Liberal amendment rules that govern in New York would have allowed the claimants in Tzumi Electronics to add an express claim for disparagement based on the factual allegations already asserted in their complaint.[14]
Conclusion
Federal courts bound to follow state laws are obligated to follow standards established by their state counterparts. Narrow construction of potential coverage (Tzumi) or overbroad assertions of exclusions (Lepore) leave these decisions open to criticism for the misapplication of New York coverage law articulated by its state courts.
*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] Tzumi Electronics, LLC v. The Burlington Insurance Company, No. 22 CIV. 9995 (KPF), 2024 WL 217764 (S.D.N.Y. Jan. 19, 2024).
[2] Id. at *8.
[3] In re Residential Capital, LLC, Nos. 12-12020 (MG), 15-01025 (DSJ), 2022 Bankr. LEXIS 3601, *47–48 (Bankr. S.D.N.Y. Dec. 21, 2022) (The Claims recited in the Settlement Agreement must be evaluated as if there were either a proposed amended complaint or filed amended complaint once the Settlement Agreement was executed).
[4] Vogelfang v. Riverhead Cnty. Jail, No. 04-CV-1727 (SJF) (AKT), 2012 U.S. Dist. LEXIS 58064, *38–39 (E.D.N.Y. Apr. 19, 2012) (acknowledging United States Supreme Court authority holding that “a final pretrial order ‘supersede[s] all prior pleadings and control[s] the subsequent course of the action.’”) (quoting Rockwell Int'l Corp. v. United States, 549 U.S. 457, 475 (2007)).
[5] 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.”)
[6] High Point Design, LLC v. LM Ins. Corp, 911 F.3d 89, 97 (2d Cir. (N.Y.) 2018) (“Buyer's Direct's discovery demands sought information related to advertisements and are extrinsic evidence that supports interpreting the counterclaim's allegation of ‘offering for sale’ to include a claim for damages due to advertising.”)
[7] Fitzpatrick v. Am. Honda Motor Co., 78 N.Y.2d 61, 68, 70 (1991) (“[A]n insured's right to a defense should not depend solely on the allegations a third party chooses to put in the complaint. This is particularly so because the drafter of the pleading may be unaware of the true underlying facts or the nuances that may affect the defendant's coverage and it might not be in the insured's (or the insurer's) interest to reveal them.”)
[8] Tzumi Electronics, No. 22 CIV. 9995 (KPF), 2024 WL 217764 at *8 (“Perhaps if Plaintiff had opted to litigate the Underlying Action on its merits and obligated the Underlying Plaintiffs to refine their position with respect to the specific violations alleged under the state consumer protection statutes, facts might have been developed that could plausibly implicate the provision on which Plaintiff now relies.”)
[9] First One Lending Corp. v. Hartford Cas. Ins. Co., No. SACV 13-01500, 2017 U.S. Dist. LEXIS 36548, *8 (C.D. Cal. Mar. 13, 2017) (“[I]n their settlement agreement with Plaintiffs, NACA again states that Plaintiffs ‘made false and disparaging statements about NACA's services’ and that ‘as a result of’ those statements, NACA ‘suffered damages to its reputation and goodwill.’”)
[10] Union Mut. Fire Ins. Co. v. Tejada, 2021 U.S. Dist. LEXIS 137766, *12–13 (S.D.N.Y. July 23, 2021) (emphasis added) (quoting Lighton Indus. v. Alllied World Nat'l Assurance Co., 348 F. Supp. 3d 167, 184–85 (E.D.N.Y. 2018)).
[11] Compare Gen. Ins. Co. of Am. v. Starr Indem. & Liab. Co., No. 14-cv-07354 (JGK), 2016 U.S. Dist. LEXIS 96582, *17–18 (S.D.N.Y. July 22, 2016) (“‘[W]ooden application of the “four corners of the complaint” rule would,’ according to the court, ‘render the duty to defend narrower than the duty to indemnify---clearly an unacceptable result.’) with Stein v. N. Assurance Co. of Am., 495 F. App'x 108, 111 (2d Cir. 2012) (“An insurer may only disclaim its duty to defend on the basis of extrinsic evidence ‘where the evidence offered . . . allow[s] a court to eliminate the possibility that the insured's conduct falls within coverage of the policy.’”) (quoting IBM v. Liberty Mut. Ins. Co., 363 F.3d 137, 148 (2d Cir. (N.Y.) 2004)).
[12] Tzumi Electronics, No. 22 CIV. 9995 (KPF), 2024 WL 217764 at *8.
[13] Natural Organics, Inc. v. OneBeacon Am. Ins. Co., 959 N.Y.S.2d 204, 207 (N.Y. App. Div. 2013) (“The statement that HON had been appointed the exclusive distributor of [Natural Organics’] products . . . could imply that NPN’s inventory . . . was unauthorized.”) (emphasis added).
[14] See David A. Gauntlett, Coverage Based on Potential for Amendment of Underlying Pleadings, https://www.gauntlettlaw.com/news/ltstlvxs1vwlifa3rni6btlbkoqkap (Sep. 3, 2023).