The History Shows That Coverage Was Not Intended to Be Restricted
The insurance industry’s argument contradicts the insurance industry’s own understanding of how occurrence-based liability insurance policies work. One of the main benefits of purchasing occurrence-based liability coverage is that it provides lasting protection. The benefits of insurance last as long as there is a possibility that someone may allege that the policyholder caused harm during the policy period. This protection against future claims is fundamental to the occurrence-based form of coverage. In insurance terms, this protection is referred to as protection against incurred but not yet reported (IBNR) losses. It means that an entity can purchase liability insurance coverage at the time it engages in potentially loss-causing operations and be assured that, as long as the amount of insurance purchased is adequate, it will have protection against future claims relating to that activity.
Insurance companies are well aware that they may be called upon to defend or indemnify their policyholder for such incurred but unknown losses. Notably, the evaluation of such risks is inherent in an insurance company’s underwriting process. Insurance companies anticipate this exact type of future claim by maintaining reserve accounts for IBNR losses—setting aside funds to meet these claims as they are reported. They even deduct IBNR losses from their federal and state income taxes. Given the insurance industry’s familiarity with the concept of IBNR losses, insurance companies cannot argue that they did not expect to pay, years after the fact, for injuries that occurred during their policy periods.
Back in 1985, the Insurance Services Office, Inc. (ISO) informed both insurance regulators and the general public of its intent to cover damage caused during the policy period regardless of when the claim happened and when the policyholder became aware of the damage:
An “occurrence” policy covers bodily injury and property damage that occurs during the policy period. When that policy period ends, all the injury and damage ultimately to be covered by the policy will have already occurred, but only some of it will be known and under handling by the company. Future claims may also come in for injury or damage unknown to the company when the policy expires, and these will also be covered if the injury or damage occurred during the policy period. These claims are called (incurred but not reported); they may come in many years—even decades—after the policy expires, and they may arise from causes and tort theories neither known nor predictable when the policy was issued.
Basic principles of insurance show that unknown incurred losses are covered by general liability policies well after the end of the policy period.
The actuarial department must also project the ultimate payout on reported open losses that continue to develop and must determine the amount of losses that have already happened but have not yet been reported to the insurance company. The latter are known as incurred but not yet reported (IBNR) losses
The insurance industry itself has demonstrated that coverage was not intended to be restricted. Rather, rights to liability insurance can, and do, follow the liabilities.
Public Policy Supports Rejecting the Insurance Industry’s Mantra
The fundamental protections associated with occurrence-based policies are not lost or forfeited when a corporation is succeeded by another. Insurance benefits relating to alleged IBNR claims should transfer with the sale of business units potentially subject to liability for those claims—particularly in an era when corporate transactions are commonplace.The transfer of IBNR insurance benefits with the alleged IBNR liabilities (1) furthers the public policy of risk spreading and (2) furthers the public policy against forfeitures.
First, it furthers the public policy of risk spreading, which occurs when liability insurance covers products liability claims. The courts have recognized that strict products liability explicitly sets forth the ability of manufacturers to obtain liability insurance as a basis for this expansion of tort law. Retroactively separating alleged IBNR liability from the IBNR insurance benefits would prevent liability insurance from fulfilling its risk-spreading role.
Second, transferring IBNR insurance benefits with the alleged IBNR liabilities that they cover also furthers the public policy against forfeitures. In a typical sale of a business division, the seller transfers to the purchaser both the assets and certain liabilities relating to the operations of that business division. If a court were to require insurer consent, there would be significant forfeitures of insurance benefits because it is not and has not been a practice in the corporate deal market to obtain insurance company consent for the transfer of accrued IBNR benefits. This would leave a consequential number of businesses, well into the future, without coverage for losses despite paying for insurance of such risks.
The insurance industry’s tired mantra is that the transfer of insurance rights or “choses in action” will somehow “increase their risk” under the policy—the argument the insurance companies deployed to persuade the South Carolina Supreme Court of in PCS Nitrogen. They argue that corporate transactions may result in a situation where they would have to defend and indemnify multiple entities. This argument mistakenly assumes that insurance companies would never owe defense obligations to multiple policyholders. To the contrary, the possibility of defending and indemnifying multiple policyholders is a risk inherent in standard comprehensive general liability policies.
The “increased risk” argument also ignores that the risks of corporate transactions already were present when the policies were written. In other words, the conclusion that a corporate transaction will “increase the risk” of the defense costs depends entirely on the false assumption that an organization cannot sell off the assets and liabilities of a business unit without the permission of its insurance company.
Commentators all agree that anti-assignment clauses in insurance policies, requiring an insurance company’s consent to any assignment or transfer of rights, do not apply to a post-loss assignment:
As a general principle, a clause restricting assignment does not in any way limit the policyholder’s power to make an assignment of the rights under the policy—consisting of the right to receive the proceeds of the policy—after a loss has occurred. The reasoning here is that once a loss occurs, . . . [i]t is now a vested claim against the insurer and can be freely assigned or sold like any other chose in action or piece of property.
Another commentator concurs:
Indeed, a specific provision against an assignment after loss is generally held unenforceable, as inconsistent with the covenant of indemnity or the right to assign a claim for money due, and as contrary to public policy.
As does yet another commentator:
The purpose of a no assignment clause is to protect the insurer from increased liability, and after events giving rise to the insurer’s liability have occurred, the insurer’s risk cannot be increased by a change in the insured’s identity.
Thus, the argument that a transfer of a chose in action relating to pre-transaction activities somehow “increases” an insurance company’s risk is a myth perpetrated by the insurance industry to avoid paying claims.
Insurance companies also argue that a policy’s anti-assignment clause prohibits the transfer of coverage unless the insurance company’s consent is obtained. This argument is inconsistent with the nature of occurrence-based liability coverage and the majority of jurisdictions nationwide. The majority of courts have held that the right to recover for pre-transaction liabilities may be freely assigned without the insurance company’s consent notwithstanding the supposed “no-assignment” clause in the policy. Such an assignment does not interfere with the insurance company’s right to choose its own indemnitee but merely involves the payment of a claim that has already accrued.
Case Law Supports the View That Policy Proceeds May Be Assigned After a Loss
Early in this century, California briefly accepted insurance industry dogma on this front in Henkel Corp. v. Hartford Accident & Indemnity Co., et al., which rejected the well-established “operation of law” approach and concluded that a successor corporation was not entitled to a defense or indemnity from its predecessor’s insurance companies for lawsuits alleging bodily injury as a result of exposure to the predecessor’s products.
California subsequently reversed Henkel in Fluor Corp. v. Superior Court. In Fluor, the California Supreme Court concluded, based on the California Insurance Code, that Henkel incorrectly determined that no-assignment clauses precluded post-loss assignments taking place before judgment. The court’s decision applied to both first-party and third-party liability insurance.
New Jersey also rejected the now reversed Henkel coverage-eliminating argument. In Givaudan Fragrances Corp. v. Aetna Casualty & Surety Co., the New Jersey Supreme Court reviewed the history of the post-loss exception and found that the loss arises at the time of the occurrence, not at the time judgment is entered.
The Fluor case similarly found that loss “should be interpreted as referring to a loss sustained by a third party that is covered by the insured’s policy, and for which the insured may be liable.” The South Carolina Supreme Court in PCS Nitrogen agreed this spring that the “reasoning in these decisions is sound, and we agree that under a third-party liability insurance policy, the loss takes place at the time of occurrence.”
Even in the absence of a written agreement to assign the chose in action explicitly, the “operation of law” rule recognized in Northern Insurance Co. v. Allied Mutual Insurance Co. operates to permit insurance recovery. In that case, Brown-Forman purchased California Cooler, a beverage company, pursuant to an asset purchase agreement. Brown-Forman was subsequently sued by the family of a child born with fetal alcohol syndrome and sought coverage for defense costs from Northern Insurance, California Cooler’s insurance company. The Ninth Circuit applied a rule of product-line successor liability and found that even though the asset purchase agreement excluded the predecessor’s liability insurance policies, the benefits of those policies transferred by operation of law.
Several courts have extended this doctrine beyond product-line successor liability. For example, in Total Waste Management Corp. v. Commercial Union Insurance Co., the court extended the Northern Insurance doctrine to an environmental liability case. In that case, the seller sold certain assets but continued its corporate existence after the asset sale. The purchaser was subsequently sued for presale environmental liabilities and sought coverage under the seller’s historical policies. The court concluded that the insurance benefits transferred to the purchaser by operation of law under a theory of corporate succession. Likewise, in B.S.B. Diversified Co. v. American Motorists Insurance Co., the court extended the product-line rule to a successor responsible for environmental cleanup where the events creating the liability occurred prior to the transfer of liability.
The vast majority of courts addressing the issue in recent years have rejected the insurance industry’s arguments on this issue and permitted assignments of insurance benefits after an occurrence takes place.
For over a century, the majority of courts nationwide have found that the right to recover for pre-transaction liabilities may be freely assigned without the insurance company’s consent notwithstanding the supposed anti-assignment clause in the policy.
In marked contrast, only one court besides the Henkel court, the Indiana Supreme Court in Travelers Casualty & Surety Co. v. U.S. Filter Corp., held a loss under a liability insurance policy does not necessarily take place at the time of the occurrence. The case involved the claims of several companies that demanded liability coverage under policies issued to their predecessors by various insurers. The coverage dispute sprang from third-party bodily injury claims related to silica exposure from working near an industrial blast machine. Notably, the court relied on the overruled logic set forth in Henkel in holding that the claims at issue in that case “did not constitute an assignable chose in action.”
Does Making This Argument Amount to Bad Faith in Claims Handling?
Does making a coverage-eviscerating argument at claims time that contradicts both the intent of the insurance policies sold and an overwhelming body of case law amount to bad faith? It may well.
Bad faith has been defined as an “absence of a reasonable basis for denial of policy benefits or failure to comply with a duty under the insurance contract and the knowledge or reckless disregard of the lack of a reasonable basis for denial. . . .” This is consistent with South Carolina’s definition of bad faith as “no reasonable basis to support the insurer’s decision.” Others have noted that there is the possibility of institutional bad faith in claims handling.
With the vast majority of jurisdictions now recognizing coverage to successors for pre-assignment loss, an “absence of a reasonable basis for denial of benefits” to such corporate successors has become increasingly discernable. In tirelessly arguing such losses are not assignable, the insurance industry persistently bases its reasoning on the overruled holding in Henkel. Insurance companies continue to force policyholders to litigate such claims despite their awareness that the law continues to develop in support of coverage of successors.
Notably, states such as South Carolina recognize common-law bad-faith claims where an insurance company’s failure to pay is contrary to well-established law and therefore “without reasonable cause.” South Carolina law permits recovery of all actual or compensatory damages and attorney fees in an ex contractu action for the breach of the covenant of good faith and fair dealing, including damages the insurance company could have reasonably foreseen resulting from its refusal to pay the claim under the policy. While courts often stay a bad-faith claim pending resolution of the underlying cause of action, a policyholder may benefit from including allegations of bad faith and preserving the right to damages and attorney fees associated with an insurance company’s wrongful denial of coverage when forced to litigate well-established law in states such as South Carolina.
An argument may be made that, in the face of the industry’s understanding of the nature of liability insurance, the overwhelming case law in favor of the policyholder view, and an “absence of a reasonable basis for denial of policy benefits,” continuing to seek to avoid coverage obligations for pre-assignment losses on the basis of anti-assignment language amount to bad faith. Given the continuing press of favorable case law for policyholders, perhaps that will be the next chapter in this decades-long story.
The near-universal rule across the country is that the right to recover for pre-transaction liabilities may be freely assigned. The recent policyholder victory in South Carolina reiterates decades of historical understanding that successors do not forfeit protections under their liability insurance for pre-acquisition operations. The consistent development of case law in support of the policyholder view presses the insurance industry to caution whether a reasonable basis exists for any continued denial of coverage to corporate successors.