A Review of Unique Insurance Coverage Issues Faced by Cities and Towns

The Interplay of Insurance and Local Governmental Tort Immunity

Navigating the liability of a city or county can be difficult. Under historic common-law principles, sovereign immunity extended to governmental entities, including municipalities, at least to when they were performing governmental functions.[2] However, over time this immunity has eroded.[3] As a result, most states have addressed the issue legislatively, passing tort claims acts and other statutes providing municipalities with statutory immunity from suits involving tort claims, unless the facts come within a specific exception. Moreover, even where such liability falls within an exception, these statutes often contain procedural requirements, limitations, and damage caps.

Still, sovereign immunity is far from absolute and can be expressly or impliedly waived under a host of circumstances. One issue that receives regular judicial attention is whether immunity may be waived through the purchase of liability insurance. In many states, the purchase of liability insurance has no effect on municipal immunity. In support of this view, courts explain that “the mere fact that a governmental unit is authorized to procure insurance does not warrant the conclusion that its immunity has been removed.”[4] Rather, “liability insurance which is procured by a governmental unit entitled to immunity from tort liability is insurance only against torts which do not come within the scope of the immunity.”[5]

In an increasing number of states, however, courts have held that where a municipality or other political subdivision purchases liability insurance, “its immunity from tort liability is removed to the extent of the coverage of the insurance.”[6] The support for this rationale is that “the primary reason for the immunity doctrine—that is, the protection of public funds—no longer exists when a governmental unit has insurance protection and, in this situation, there is no need for application of the doctrine.”[7] This potential waiver raises a host of complex questions for practitioners.

For instance, because the governmental unit must be insured before it can be sued, extensive discovery regarding insurance may be necessary and an allegation of insurance coverage may be required in the pleading stage of a claim.[8] Even if these steps are followed, this paradigm still begs the question as to whether it is the purchase of insurance that constitutes waiver or the actual provision of coverage for a particular claim. In other words, how does the waiver operate if the insurance lapses or a condition precedent to coverage is not satisfied? Similarly, how should the waiver be treated when coverage is debatable? Moreover, if a policy indicates that it is not intended to act as a waiver, is such a provision enforceable?

Insureds and insurers need to understand these dynamics in order to understand the risk profile being insured. Indeed, as one leading treatise has suggested, it may be appropriate for insurers to base their premiums on the insured being immune or being subject to suit.[9] However, even that notion raises additional questions, such as the following: “[I]f the relevant jurisdiction allows direct actions and the insured is held not to have waived its immunity by purchasing insurance, can the victim avoid the insured’s immunity from suit by the device of proceeding directly against the insurer?”[10]

Securities Claims Against Municipalities

Congress has specifically exempted offerings of municipal securities from the registration requirements and civil liability provisions of the Securities Act and from the reporting requirement provided by the Exchange Act.[11] However, to provide accountability notwithstanding the exemptions, the Securities and Exchange Commission (SEC) issued Rule 15c2-12, providing that underwriters may not sell municipal securities without procuring a commitment from the issuer that it will provide continuing disclosures regarding itself and the securities, including information about its financial condition and operating data (the “continuing disclosure obligations”). The SEC may file enforcement actions under either section 17(a) of the Securities Act of 1933 or section 10(b) of the Exchange Act, or both, against issuers for inaccurately stating in final official statements that they have substantially complied with their continuing disclosure obligations.

Despite this rule, SEC actions against municipalities have been historically sparse. As a result, compliance with the continuing disclosure obligations has been erratic, especially for smaller communities with small legal budgets. However, the financial crisis of 2008 created solvency issues for political subdivisions around the county, and the notion of increased enforcement became a possibility. This notion became reality when, in a settled administrative proceedings announced in July 2013, the SEC for the first time charged a municipal bond issuer for misstatements about compliance with continuing disclosure undertakings.[12]

This action is notable to insurance counsel in that liability policies typically issued to municipalities are often ill equipped to address an SEC action. Indeed, because SEC actions against municipalities were historically nonexistent, consideration of such actions by policy language in local government policies is rare. Some policies clearly (though perhaps inadvertently) provide coverage for such claims, while others include clear exclusions. However, a large number of the policy forms do not expressly address the issue one way or the other, and the case law construing directors’ and officers’ policies is not always sufficiently analogous to provide clear guidance. As a result, municipalities need to review their specific policy language and work with their brokers to ensure such claims are within the scope of their coverage. On the other hand, insurers not intending to provide such coverage should consider express exclusions to address the issue.

As would be expected, the West Clark action created concern for countless municipal bond issuers that had not been faithful in meeting their continuing disclosure obligations. As a result of that concern, in March of last year, the SEC announced a self-reporting initiative for municipal bond issuers. The initiative is called the Municipalities Continuing Disclosure Cooperation (MCDC) Initiative. The MCDC invites issuers to voluntarily report to the SEC possible violations involving materially inaccurate statements in official statements relating to an issuer’s prior compliance with their continuing disclosure obligations. Participation in the MCDC is initiated by completing a questionnaire made available by the SEC. By completing the questionnaire, the issuer “consent[s] to the applicable settlement terms under the MCDC Initiative.” Those settlement terms require the issuer to, among other things, “consent to the institution of a cease and desist proceeding under Section 8A of the Securities Act for violation(s) of Section 17(a)(2) of the Securities Act.” In consideration of an issuer’s acceptance of such terms, the SEC’s Enforcement Division will recommend that the SEC accept a settlement in which there is no payment of any civil penalty by the issuer.

Anecdotally, MCDC participation was robust. However, the MCDC Initiative covers only eligible issuers (and underwriters). The SEC still may initiate enforcement actions against municipal officials and employees and may seek remedies against those individuals. Moreover, those individuals as well as the issuers may still be subject to bondholder suits or to enforcement actions by state regulators or agencies other than the SEC. Of course, this raises the possibility that, by participating in the MCDC Initiative without involving its insurer, an insured may violate its policy’s notice or cooperation clauses and jeopardize coverage for individuals in subsequent claims. Thus, counsel representing municipalities may be wise to inquire about the extent of their client’s MCDC participation and consider notifying its insurers.

The Potential Need to “Over-Notice” on Wrongful Imprisonment Claims

Wrongful incarceration cases generally include allegations of malicious prosecution by public entities or law enforcement personnel, leading to the wrongful incarceration. The tort of malicious prosecution has been described as “sui generis,”or unique, because unlike most torts that accrue when damages are sustained by a claimant, the tort of malicious prosecution accrues when criminal proceedings are favorably terminated, not when the injury or damage to the claimants occurs.[13] This circumstance leads to disagreements as to the appropriate trigger of coverage for a claim involving malicious prosecution.[14]

Policies providing coverage for such claims are generally occurrence-based, and most courts have held that claims for malicious prosecution implicate insurance policies in effect at the time of the commencement of the wrongful prosecution, not those in effect when the claimant is ultimately exonerated.[15]

While the rationale of the cases differ somewhat, the majority view is generally based on the concept that public entity liability insurance is intended to cover the acts or omissions of an insured leading to an injury and that in the case of a malicious prosecution, the conduct giving rise to the cause of action occurred at or near the time of the prosecution, not later, when the individual is exonerated.

In contrast, the U.S. Court of Appeals for the Seventh Circuit rejected the majority rationale and joined a distinct minority of courts in holding that the termination of a malicious prosecution is the occurrence or circumstance that triggers insurance coverage.[16] The Seventh Circuit decisions were all based on Illinois law, specifically Security Mutual Casualty Co. v. Harbor Insurance Co.,[17] the only Illinois case that had addressed the issue and arguably supported the “minority view.”

As a general matter, the minority approach reasons that exoneration is a necessary element of the tort of malicious prosecution and that insurance coverage is therefore triggered when the cause of action accrues. An exoneration-as-trigger approach has been advocated by some as more flexible, in that insurers can potentially adjust their exposure by changing the language in their policies, if need be, to define the triggering event as the misconduct at issue, if that is the underwriting intent.

In September 2014, in St. Paul Fire & Marine Insurance Co. v. City of Zion,[18] the Appellate Court for the Second District of Illinois rejected the Seventh Circuit’s approach, expressly noting that the Security Mutual decision was “not helpful” to its analysis, and after weighing the rationale for both the majority and minority views, the court ultimately found coverage triggered in that case at the time of the initial prosecution. Based on the specific policy language at issue in that case, the court found that the “injury” caused by malicious prosecution results at the commencement of a malicious prosecution, not at the time of a favorable termination. The court reasoned that the favorable termination of a criminal case cannot be the injury or occurrence that triggers coverage because the termination actually marks the “beginning of the judicial system’s remediation” of the wrong committed, not the commencement of an injury or damage.[19]

More recently, on December 29, 2014, the court again applied the same reasoning in Indian Harbor Insurance Co. v. City of Waukegan.[20] In Indian Harbor, the policy language at issue responded to “wrongful acts” during the policy period that result in injury, including malicious prosecution. The court reasoned that, based on such language, the initiation of the allegedly malicious action was the triggering event for purposes of determining insurance coverage. Until the Illinois Supreme Court weighs in on the issue, the City of Zion decision is the leading published state court opinion to address the trigger of coverage for malicious prosecution claims. And under such precedent, the Seventh Circuit “minority view” cases referenced above may no longer be viewed as particularly persuasive, at least in cases applying Illinois law.

It is important to note that none of the courts that have addressed the trigger of coverage for wrongful incarceration cases have adopted a “continuous trigger” or “multiple trigger” of coverage approach, along the lines of that adopted in certain jurisdictions in the context of certain mass torts or other latent injuries that progress over time. The rationale for this outcome is at least twofold. First, because insurance coverage for wrongful incarceration cases is often written to respond to the wrongful acts or conduct of an insured, the conduct at issue in a wrongful incarceration case generally ends once the individual is incarcerated. Second, while a wrongfully incarcerated person may endure emotional distress over the length of time of their incarceration, the emotional distress is not an ongoing injury in and of itself ; instead, it is a continuing ill effect of the initial violation of the individual’s rights. Of course, policyholders continue to argue in favor of a “continuous trigger,” urging that claimants suffer both new and continuing injuries each day that they are incarcerated.

It is important to recognize that public entities often maintain a variety of primary liability policies, as well as excess or umbrella coverages, most often issued by a variety of different insurers, using different insurance language. The terms and provisions that may be at issue in a wrongful incarceration case vary widely, sometimes even within a single policyholder’s insurance program or within the same policy year.[21] Moreover, many states have yet to address the trigger of coverage for wrongful incarceration cases, and the law in this area is still developing. As the number of exonerations grows, public entities and their insurers are sure to debate these and other issues, given the need for public entities to maximize any potential insurance coverage available to respond to their liabilities.

As a result, if a public entity or its employees are ever pursued in a wrongful incarceration context, or any other context, it is extremely important for the public entity to identify and obtain complete copies of all of its policies in effect during the potentially applicable years in question, at all layers of coverage, and to thoroughly analyze the specific terms of those policies in light of the facts and allegations in a particular case and the law in the jurisdiction at issue. Ultimately, given the state of the law and variations in policy language, it may be advisable for the insured to notify all carriers that issued policies during the period of arrest, the period of exoneration, and each period in between. Moreover, when renewing their insurance, insureds should be wary of changing policy forms at the risk of creating gaps in potentially available coverage.

Open Records Law: Making Confidential Settlements an Oxymoron

Nearly every state has some form of a public records law. Under such laws, municipalities are generally required to disclose settlement agreements resolving suits and or claims, regardless of whether such settlements have been designated as “confidential.” For instance, in holding that a confidential settlement agreement must be disclosed, the court in Miller v. Academy School District No. 20[22] explained that “[a]n agreement by a governmental entity that information in public records will remain confidential is insufficient to transform a public record into a private one.”[23]

Moreover, as the court in Burnett v. County of Gloucester[24] explained, “agreements may on occasion be executed by agents of the County, consisting of outside attorneys or insurance adjusters, [but] they nonetheless bind the county as principal, and the agreements are made on its behalf.” Thus, such agreements are not outside the scope of an open records law.[25] As a result, coverage and defense counsel must be reminded that, even where the insurer has full control of a municipality’s claim defense and settlement, it is still acting as its insured’s agent. Thus, it must exercise appropriate discretion in agreeing to particular settlement terms, stipulating to protective orders, agreeing that access to documents or information will be limited, or making concessions as part of its claim resolution.

Keywords: litigation, insurance coverage, sovereign immunity, statutory immunity, municipal bonds, wrongful imprisonment, malicious prosecution, confidential settlements

Brent W. Huber is a partner and Nicholas B. Reuhs is an associate at Ice Miller LLP, Indianapolis. Michelle R. Valencic is a partner at Clausen Miller PC, Chicago. Niquelle Allen Winfrey works in the City Attorney’s Office, Gary, Indiana.

[1] This paper is a summary of general information and is intended for discussion only. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of any of the authors’ clients, employers, or law firms.
[2] See, e.g., Porter v. Delmarva Power & Light Co., 488 A.2d 899  (Del. Super. Ct. 1984); Oien v. City of Sioux Falls, 393 N.W.2d 286  (S.D. 1986).
[3] See, e.g., 1 Civil Actions Against State and Local Government § 1:8 (discussing abrogation of common law immunity).
[4] “Liability or Indemnity Insurance Carried by Governmental Unit as Affecting Immunity from Tort Liability,” 68 A.L.R.2d 1437 § 1 (b).
[5] 68 A.L.R. 2d 1437 § 1 (b).
[6] 68 A.L.R. 2d 1437 § 1(b) (collecting cases and enumerating jurisdictions); see also, e.g., Herring ex rel. Marshall v. Winston-Salem/Forsyth Cnty. Bd. of Educ., 529 S.E.2d 458  (N.C. Ct. App. 2000) (a board of education’s immunity deemed waived by the act of obtaining insurance to the extent the board is indemnified by insurance for negligence or tort).
[7] 68 A.L.R.2d 1437 .
[8] See, e.g., “Validity and Construction of Statute Authorizing or Requiring Governmental Unit to Procure Liability Insurance Covering Public Officers or Employees for Liability Arising Out of Performance of Public Duties,” 71 A.L.R.3d 6  (collecting cases holding that “the complaint must allege that the governmental unit had waived its governmental immunity by purchasing the insurance”).
[9] 7A Couch on Insurance § 103:3 (3d ed.).
[10] 7A Couch on Insurance § 103.3.
[11] See Exchange Act Release No. 33741 (Interpretive Guidance).
[12] See In the Matter of West Clark Comty. Schs., Securities Act Release No. 9436, Exchange Act Release No. 70057 (July 29, 2013).
[13] See St. Paul Fire & Marine Ins. Co. v. City of Zion,2014 IL App. 2d 131312 , 18 N.E.3d 193  (2d Dist. 2014) (citing Muller Fuel Oil Co. v. Ins. Co. of N. Am., 232 A.2d 168  (N.J. Super. Ct. App. Div. 1967) (the first case to have addressed the issue)).
[14] The trial court decision in City of Zion includes a detailed recitation of the competing cases and rationale on both sides. See St. Paul Fire & Marine Ins. Co. v. City of Zion, 2013 WL 3476145, at n.9 (Ill. Cir. Ct. May 10, 2013).
[15] City of Zion, 2013 WL 3476145, at n.9 (citing City of Erie v. Guar. Nat’l Ins. Co.,935 F. Supp. 610 , aff’d, 109 F.3d 156, 160  (3d Cir. 1997); Royal Indem. Co. v. Werner,979 F.2d 1299  (8th Cir. 1992); Gulf Underwriters Ins. Co. v. City of Council Bluffs, 755 F. Supp. 2d 988  (S.D. Iowa 2010); Billings v. Commerce Ins. Co., 936 N.E.2d 408  (Mass. 2010); Harbor Ins. Co. v. Cent. Nat’l Ins. Co., 165 Cal. App. 3d 1029, 1034  (Cal. Ct. App. 1985); Town of Newfane v. Gen. Star Nat’l Ins. Co., 784 N.Y.S.2d 787  (N.Y. App. Div. 2004)).
[16] See, e.g., Northfield Ins. Co. v. City of Waukegan, 701 F.3d 1125  (7th Cir. 2012); Am. Safety Cas. Ins. Co. v. City of Waukegan, 678 F.3d 475  (7th Cir. 2012); Nat’l Cas. Co. v. McFatridge, 604 F.3d 335  (7th Cir. 2010).
[17] 65 Ill. App. 3d 198  (1978), rev’d, 77 Ill. 2d 446  (1978).
[18] 2014 IL App. 2d 131312 , 18 N.E.3d 193  (2d Dist. 2014)
[19] City of Zion,18 N.E.3d at 200 (citing Town of Newfane, 784 N.Y.S.2d 787 ).
[20] 2014 Ill. App. Unpub. LEXIS 2965, 2014 IL App. 2d 140293-U (Ill. App. Ct. 2d Dist. Dec. 29, 2014) (unreported).
[21] The City of Zion case discussed above clarified the law in Illinois; however, its holding was heavily influenced by the precise policy language at issue in that case. See also Indian Harbor, 2014 Ill. App. Unpub. LEXIS 2965, 2014 IL App. 2d 140293-U (deciding the case based on the policy language at issue). The court did not create a broad, sweeping rule as to the appropriate trigger of coverage for malicious prosecution claims in general, and it expressed no opinion as to the appropriate trigger under policies with differing language.
[22] No. 04CV1681, 2006 WL 3522507, at *5 (Colo. Dist. Ct. Sept. 28, 2006).
[23] See also, e.g., Anchorage Sch. Dist. v. Anchorage Daily News, 779 P.2d 1191, 1193  (Alaska 1989) (a public agency may not circumvent the statutory disclosure requirements by agreeing to keep the terms of a settlement agreement confidential).
[24] 415 N.J. Super. 506, 512–13, 2 A.3d 1110, 1114 (App. Div. 2010).
[25] Burnett,415 N.J. Super. at 512–13.

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