The most common structure of an insurance coverage lawsuit involves the filing of a complaint by a policyholder against one or more insurers. However, it is surprisingly frequent for the roles to be reversed, and for an insurer to file its own action against its policyholder, seeing a declaratory judgment that no coverage is owed. This article will discuss the historical context and reasons why insurers make such a move, and strategies that policyholders can employ to protect their interests when it happens.
The phenomenon of insurers suing policyholders became common in the 1980’s and 1990’s, when most large industrial companies in the United States pursued insurance recovery for the costs of environmental clean-up. Insurers viewed these claims as a major threat to their profitability and business model, due to (a) the massive amounts at stake in these type of claims, (b) the fact that they were brought under decades-old occurrence-based policies, which insurers had considered to be closed, (c) they were not factored into the underwriting analysis, and in many cases, insufficient reserves were in place.
For these reasons, most major property and casualty insurers considered environmental insurance coverage claims brought by Fortune 500 company worthy of “bet the company” style litigation. Filing a preemptive declaratory judgment actions against policyholders was part of their playbook for these high-stakes cases. The insurers’ predominant rationale for rushing to the courthouse was to choose the court in which litigation would proceed. This was because insurance recovery is based purely on state law, and several key coverage issues had been decided in diametrically different fashion by courts in different states. Examples include the interpretation of the pollution exclusion; whether late notice would defeat coverage; the level of knowledge necessary to establish “expected and intended;” and, whether the words “as damages” include injunctive clean up orders. The insurers’ belief, which was at least partially true, is that bringing suit in a jurisdiction with favorable law on the coverage defenses that they intend to assert would give them an advantage.
Filing suit in a given jurisdiction does not guarantee that the substantive law of that jurisdiction will apply, because the typical environmental insurance fact pattern leads to complex choice of law issues, and often requires a court in one jurisdiction to apply the law of another. But courts often lean toward applying their own law, either directly, or indirectly by reading the cases from another jurisdiction through the lens of their own state’s law. For that reason, insurers frequently filed their declaratory judgment actions in jurisdictions where they perceived the law as favorable. Forum shopping can be a dangerous game, though, because often the disputed issues change over the course of a complex case. So an insurer might file its declaratory judgment action in State A to get the benefit of favorable law on a certain issue, only to learn later that State B has better law on other issue(s) that have become more significant.
Another reason why insurers historically filed declaratory judgment actions was an effort to catch the policyholder unprepared. Some policyholders did not have experienced outside counsel ready to represent their interests, and others did not have appetite for expensive, protracted coverage litigation. Insurers believed, often correctly, that if they could secure the upper hand in terms of forum, they could obtain quick victories on summary judgment, or force policyholders into low dollar settlements.
Environmental insurance mega-cases are largely a thing of the past, but the insurers’ strategy of filing declaratory judgment actions in certain circumstances lives on. A review of insurance declaratory judgment filings across the country on any given day shows anywhere from 10% to 30% of the insurance lawsuits are filed by insurers. For instance, during the two-day period January 9-10, 2020, there were 55 insurance lawsuits filed nationwide, and 13 of those (i.e., 24%) were filed by insurers rather than policyholders.
Clients often ask why insurers take that step, and the best answer is that the same factors driving insurers to file proactively during the environmental coverage days are still at work – a perception that differences in state law make one forum favorable to another, and/or a perception that the policyholder is not ready for litigation, and therefore an advantage can be secured by making the first move.
The more important question, however, is what strategies can be employed by the policyholder to counteract this move on the part of an insurer. First and foremost, policyholders and their counsel need to anticipate that there is always a possibility of a preemptive filing by an insurer. An experienced policyholders’ lawyer always advises his/her client at the very outset of an engagement that there is a chance that the policyholder may unexpectedly find itself a defendant in court after submitting a claim. Discussing this possibility up front is critical. If an action is filed against an insured who has no idea that it might happen, the first conversation following the filing will not be pleasant for the lawyer or for the client.
The best approach is to have a litigation strategy mapped out at the time when the claim is submitted to the insurer, so that the policyholder is prepared to move quickly. The most important question after a suit is filed is whether the forum chosen by the insurer is a good one from the policyholder’s perspective. Sometimes the insurer and policyholder are looking at the same case very differently, and the same forum chosen by the insurer for one reason might appeal to the policyholder for a different reason(s). If that is the case, the policyholder can simply shift into litigation mode and fight out the claim in the forum selected by the insurer. In this scenario, the policyholder would assert its claims for coverage in the form of a counterclaim, and the matter would proceed like any coverage litigation. Once the litigation moves forward, the fact that the party labels are reversed (i.e., the party who would normally be the defendant is the plaintiff, and vice versa) has little to no effect on the parties’ substantive or procedural positions.
Often, though, the policyholder will not want to litigate in the forum chosen by the insurer. Insurance coverage disputes are known for involving forum battles, given the potential for different results under the laws of different states. When taking on a forum battle, time is of the essence, because one factor that courts will use to decide the appropriate forum is which case was filed first. The modern approach of most courts is to treat lawsuits filed just a few days apart as filed at the same time, since there will have been no substantive progress in one case relative to another. But if the filings are several weeks or months apart, the earlier-filed case will be at a decided advantage.
Moreover, once two competing cases are filed in different jurisdictions, an important factor in deciding which will give way to the other is the extent to which the judge has devoted attention to the merits of the case. Therefore, parties in competing cases often will try to generate activity through early substantive or discovery motion practice, so that it can be argued that their own case is further along than the other. Obviously, a policyholder will be at a disadvantage if the insurer is prepared for litigation and pushing forward with all deliberate speed, while the policyholder is scrambling to select counsel and plan its strategy. For these reasons, it is imperative that a policyholder have a litigation plan at the ready, that can be implemented on short notice, before submitting a significant claim to an insurer.
There may be scenarios where a policyholder does not want to take on any risk of being ambushed by an insurer declaratory judgment action. This could be a case where the claim is substantial, and there is a clear difference in the law among the potential fora that could be chosen. In this case, a conservative strategy would be for the policyholder to file its own action simultaneously with the submission of its claims notice. The policyholder could inform the insurer of the filing and offer to stay the action for a reasonable time to allow the parties to determine whether or not there is a dispute over coverage. If there is no resolution, then the policyholder’s choice of forum is locked down. This approach provides the policyholder with maximum control over where the litigation will proceed, and when it will proceed, rather than ceding this control to the insurer.
Finally, the silver lining to being sued by an insurer is the possibility of fee shifting in certain jurisdictions. The most famous rule is from New York, where the Court of Appeals held in 1979 that when an insurer casts its policyholder into a defensive posture by filing a lawsuit, and it turns out that the insurer’s position is wrong, the insurer must pay the policyholders’ attorneys’ fees and costs. Mighty Midgets, Inc. v. Centennial Insurance Company, 389 N.E.2d. 1080. The Mighty Midgets rule was applied most recently in the case United Specialty Insurance Company vs. Lux Maintenance & Ren. Co., 2019 U.S. Dist. LEXIS, 201805 (Nov. 20, 2019). So, if a policyholder is sued by its insurer, it should check promptly to see if there is an argument for a fee shifting rule such as Mighty Midgets.
