Category Archives: Strategic risk management

Spilled Milk: District Court Judge Sides with Policyholder in Recall Damages Dispute

By Jonathan Cohen and Aisha Cassis

On January 8, 2013, a Minnesota federal district court granted summary judgment in favor of a policyholder who sought coverage from its commercial general liability insurer for contract damages stemming from the recall of instant milk.  In 2007, the policyholder, Main Street Ingredients (“MSI”), purchased instant milk from Plainview Milk Products Cooperative (“Plainview”).  MSI entered into a contract under which it resold that milk to Malt-O-Meal Company (“MOM”).  MOM incorporated that milk into its instant oatmeal.  In 2009, the Food and Drug Administration detected unsanitary conditions and salmonella at Plainview’s manufacturing facility.  As a result of this, Plainview issued a recall of all instant milk sold from 2007 forward.  This included the milk that MSI sold to MOM that MOM had incorporated into its instant oatmeal products.  That same year, MOM sued MSI and Plainview seeking damages that it had incurred as a result of the recall.  MSI settled with MOM for $1.4 million.  MSI sought both liability and defense costs from its insurer, Netherlands Insurance Company (“Netherlands”), which had defended the claim under a reservation of rights.

On March 2, 2011, Netherlands filed a declaratory judgment action (The Netherlands Insurance Company v. Main Street Ingredients, LLC, et al., No. 11-533, 2013 U.S. Dist. LEXIS 2685 (D. Minn.)), against MSI seeking a declaration that it had no duty to defend or indemnify MSI.  MSI counterclaimed that Netherlands was required to do so.  Both parties moved for summary judgment, and the Court sided with the policyholder on each issue.

First, the Court held that, although the underlying litigation stemmed from a breach of contract dispute, there had been an occurrence under the policy because (i) the contractual liability itself arose from the recall of the instant milk and (ii) there was no evidence in the record suggesting that MSI intended to injure MOM.

Second, the Court held that the known loss provision could not operate to preclude coverage where MSI did not have knowledge of the damage until it received the recall notice from Plainview.  This did not occur prior to Netherlands’s policy period.

Third, the Court found that property damage was present regardless of the fact that the instant milk had never tested positive for salmonella.  Additionally, the Netherlands policy provided coverage not only for property damage, but also for damages incurred because of property damage.  Thus, the damages included costs stemming from MOM’s destroyed inventory, credits and fees to customers, recall freight and additional costs.

Finally, the Court refused to apply the “your product,” “impaired product,” or “recall” exclusions because none of those exclusions barred coverage for damages associated with a third party’s product.  Notably, the Court cited well-established New Jersey case law that establishes the “recall” exclusion “has no applicability when the claim is for property damage claimed to have been suffered by another property owner.” Id. at *18 (citation omitted).

This decision should give food companies further support in seeking coverage for liabilities arising out of product recalls.

Rise in Food Contamination Calls for Proactive Risk Management in 2013

By Jonathan M. Cohen and Emily P. Grim

Despite improvements in food safety over the last two decades, 2012 saw no shortage of recalls due to food contamination.  For example, one Indiana farm recalled all cantaloupes from its 2012 growing season after the fruit was linked to an outbreak of salmonella that killed three and sickened hundreds.  Another salmonella outbreak caused health officials to shut down the Vancouver, Washington branch of a popular Mexican restaurant.

The outbreaks of 2012 were not an anomaly.  Recent studies show that foodborne illness may be on the rise.  According to the Center for Disease Control, approximately 48 million Americans fall ill, 128,000 are hospitalized, and 3,000 die each year due to food contamination.  That means that 15% of Americans can expect to have a foodborne illness annually.  And, a recent study by the U.S. Public Interest Research Group estimates that the number of Americans falling ill or dying from eating tainted food has increased 44% since 2011.

Several new incidents in the last month suggest that this trend will continue in 2013.  In December, the Food and Drug Administration discovered salmonella contamination at the same Indiana farm linked to the August outbreak.  Last week, a national restaurant chain issued a recall of a smoked salmon product after its supplier notified the company of a potential bacteria threat.

This trend highlights the importance of careful risk mitigation plans for food companies at all levels of the supply chain.  To procure the best risk management portfolio for its needs, a company should begin by evaluating its potential exposure with as much specificity as possible.  A company with foreign manufacturers, for example, should not identify its risk merely as “concerns about the supply chain” or “concerns about exposure from foreign manufacturing,” but should break its concern into more specific and detailed aspects of its concerns, such as “concern about shipping interruptions due to weather,” “concerns about interruptions or liabilities arising from pandemics,” or “uncertainty regarding quality control, storage, and expiration dates.”  The more a company breaks down risk into specific and detailed concerns, the better that company can evaluate the protections the company has to avoid or pay for those risks.

Next, companies must identify the best way to transfer their risk, whether via insurance coverage, indemnities, or other mechanisms.  For example, a food manufacturer might seek one or more policies designed to cover the cost of testing and destroying the product, cleaning contaminated equipment, notifying third parties of the recall, and damage to the manufacturer’s reputation.  Depending on their position in the supply chain, certain companies might also seek third-party coverage for potential lawsuits by supermarkets for economic losses or claims by customers sickened by contaminated food.

An effective risk evaluation also should identify legal hurdles that could impede a company from accessing coverage.  Some policies, for instance, contain contamination or microbe exclusions that insurers likely would assert bar coverage for many recall events.  Food companies should be on the look-out for other potential coverage limitations as well, such as limits of liability that could cap a policyholder’s recovery or deductibles that could reduce or eliminate coverage for the types of problems that a food company might confront.  Even in the face of such exclusions or limitations, though, many policyholders may have strong arguments that these provisions do not apply to the specific types of risks or liabilities the company has.  A thorough knowledge of the fast-evolving legal landscape of liability, property, and recall coverage will enable companies to draft the best possible coverage language.

Food contamination may be on the rise, but by performing a comprehensive analysis of risk exposure and potential coverage options, companies can ensure that they have the right protection.

Companies Need to Review Their Insurance as FDA Announces First Rules Under FSMA

By Jonathan M. Cohen

On January 4, 2013, the Food and Drug Administration (“FDA”) issued the first two rules that will put into effect the Food Safety Modernization Act (“FSMA”), a law passed by Congress in 2011 that is designed to prevent food-borne illness on a nationwide basis.  The FDA has said that both FSMA and its rules are intended to constitute a proactive rather than a reactive approach to food-borne illness.  Both rules will be subject to a 120-day public comment period before they can take effect.

The first proposed rule, the Preventive Controls for Human Food Rule, would require food companies – whether they manufacture, process, pack or store food – to develop formal plans to prevent their products from causing food-borne illness through contamination.

The second proposed rule, the Produce Safety Rule, would require farms that grow, harvest, pack or hold fruits and vegetables to follow science- and risk-based standards for the production and harvesting of produce on farms.  These standards are aimed at preventing contamination in the growing, harvesting, packing, and holding processes.

Although these two new proposed rules are the first ones that the FDA has proposed to implement FSMA, they likely are not the last.  FSMA, which runs for 1,200 pages, covers a wide range of food-related issues.  It provides specific controls and hazards that companies must address.  Although the FDA had not met the deadlines for rolling out rules that FSMA set out, FSMA has many provisions that require FDA rules or regulations for implementation.  In a press release also issued on January 4, 2013, the FDA stated that it soon would propose additional rules, including rules regarding the overseas growth and processing of food products.

Together, FSMA and the two new proposed rules (as well as future rules) can have a significant effect on food companies’ liability risk should a food-borne contamination or recall occur.  Companies at all levels of the food supply chain thus should be aware that FSMA and related rules could change the effectiveness of their current risk management and mitigation strategies.  Because food companies still have time before these two proposed rules will become effective, and before the FDA proposes other rules, now is the time that companies need to review their risk mitigation strategies, including by reviewing their insurance and indemnification agreements, to ensure that they protect themselves in this evolving legal environment.

Jonathan Cohen to Speak at GMA Litigation Webinar on December 5th

Developed by GMA experts, this webinar,  Current Issues and Trends in Social Media, Supply Chain Litigation and Foodborne
Illness Outbreaks, will address current litigation “hot topics” in the food, beverage, and CPG industry. Attendees will gain valuable insights on social media and how it relates to litigation, supply chain risks and litigation, and will receive an update on foodborne illness outbreaks. Jonathan Cohen will host a discussion on The Weakest Link: Supply Chain Resilience, Risk and Litigation.  He will dicuss how companies can address changing supply chain risks and the availability of insurance and other financial products to address those risks.  the webinar will take place on December 5, 2012.  For more information, or to register for this webinar, please click here.

Cyber-Security Issues Receiving Ever-Increasing Attention, Including From Congress and Governmental Agencies

By Barry Buchman and Adrian Azer

On the heels of a recent survey that found that cyber-security is becoming the primary concern of corporate general counsels and directors, see C. Dunn, Cybersecurity Becoming No. 1 Concern for GCs and Directors, Corporate Counsel, Aug. 15, 2012, the United States government is increasingly taking an active role in addressing cyber-security issues.

On September 19, 2012, Senator John D. Rockefeller IV – Chairman of the U.S. Senate Committee on Commerce, Science and Transportation – sent a letter to the chief executive officers of all Fortune 500 companies addressing the need for better cyber-security measures and requesting their active involvement in developing such measures.  Senator Rockefeller stated that “the cyber threats we face are real and immediate, and Congress’s failure to pass legislation this year leaves the country increasingly vulnerable to a catastrophic cyber attack.”  Moreover, Senator Rockefeller noted that most executives “recognize the gravity of this threat and that their companies would benefit from deeper collaboration with the government.”

Senator Rockefeller’s letter comes on the heels of litigation commenced by the Federal Trade Commission (“FTC”) against various companies based on their alleged failure to maintain appropriate cyber-security measures.  The letter also follows guidance by the U.S. Securities and Exchange Commission (“SEC”) regarding the disclosure requirements for public companies regarding cyber-security risks and breaches.

On June 12, 2012, the FTC commenced a declaratory judgment proceeding against, among others, Wyndham Worldwide Corporation (“Wyndham”), seeking injunctive relief against Wyndham for its failure to “maintain reasonable and appropriate data security for consumers’ sensitive personal information.”  In its complaint, the FTC alleged that Wyndham’s “failure to maintain reasonable security allowed intruders to obtain unauthorized access to the computer networks of Wyndham Hotels and Resorts, LLC, and several hotels franchised and managed by Defendants on three separate occasions in less than two years.”  This lack of adequate cyber-security measures led to “fraudulent charges on consumers’ accounts, more than $10.6 million in fraud loss, and the export of hundreds of thousands of consumers’ payment card account information to a domain registered in Russia.”

Moreover, the FTC commenced enforcement actions against two businesses – EPN, Inc. and Franklin’s Budget Car Sales, Inc. (“Franklin”) – alleging that the businesses illegally exposed “sensitive personal information of thousands of consumers by allowing peer to peer file-sharing software to be installed on their corporate computer systems.”  Specifically, the businesses’ failure to adopt adequate cyber-security measures subjected personal information, such as social-security numbers, to disclosure.  The FTC entered into settlements with both businesses, whereby “both companies must establish and maintain comprehensive information security programs.”  The settlements also bar “misrepresentations about the privacy, security, confidentiality, and integrity of personal information collected from consumers.”

Further, as previously addressed in our article on the availability of insurance coverage for cyber-security incidents, on October 13, 2011, the SEC issued guidance regarding the disclosure requirements for public companies arising from cyber-security risks and breaches.  See Importance Of Procuring Cybersecurity Insurance Coverage, Law360, June 29, 2012.[1]  The SEC noted that, in disclosing cyber-security risks, it would be prudent for companies to include a “[d]escription of relevant insurance coverage.”  See id. (citation omitted).

This increased involvement by the federal government further evidences the importance of cyber-security and protecting against cyber risk through, among other things, adequate insurance coverage.  As noted in our recent article, companies may have several avenues to coverage for losses associated with cyber-security incidents.  Indeed, since we published that article, the Sixth Circuit has issued a pro-policyholder decision regarding coverage for such losses, holding that losses resulting from the theft of customers’ banking information are covered under a commercial crime policy’s computer fraud endorsement.  See Retailer Ventures, Inc. v. Nat’l Union Fire Ins. Co., — F.3d –, 2012 WL 3608432 (6th Cir. Aug. 23, 2012).  This ruling further illustrates that the coverage provided by commercial insurance policies can be an extremely valuable corporate asset to companies dealing with cyber-security issues. Companies can maximize the benefits of this asset by acting proactively to analyze their insurance portfolio now and by being willing to question, and challenge where appropriate, coverage denials from their insurers.

Protecting Your Bottom Line from the Cost of National Association of Securities Dealers and FINRA Investigations

By Rachel Kronowitz and Adrian Azer

When self-regulatory organizations (“SRO”), such as the Financial Industry Regulatory Authority (“FINRA”), commence an investigation or proceeding, member firms are typically concerned with the financial impact that both the defense costs and any ultimate payment obligation will have on their bottom line.  With the United States Second Circuit Court of Appeal’s decision in Fiero v. Financial Industry Regulatory Authority, Inc., 660 F.3d 569 (2d Cir. 2011) that SRO fines are not judicially enforceable, member firms may be able to obtain balance sheet protection from these proceedings through insurance coverage. 

Historically, Errors & Omissions (“E&O”) or Director & Officer (“D&O”) insurance policies excluded coverage for “fines or penalties imposed by law.”  Since Fiero precludes SROs from judicially enforcing their fines, these fines can no longer be “imposed by law” and member firms have strong arguments that insurers must provide indemnity and reimburse them for any defense costs incurred.  

This access to insurance coverage is significant for multiple reasons:  it not only reduces the financial impact of SRO investigations and proceedings, but also negates a significant point of leverage that SROs have when negotiating settlements with member firms.

I.  Overview of Fiero and Its Progeny

In Fiero, the Second Circuit faced the question of whether SROs, such as FINRA, can judicially enforce the collection of fines against member firms.  SeeFiero, 660 F.3d at 574.  The Second Circuit ruled that SROs do not have the ability to judicially enforce their fines under the Securities Exchange Act of 1934 (the “Exchange Act”).  Id. In reaching this conclusion,the Second Circuit noted that Congress intentionally did not provide SROs access to the judicial system to enforce their fines:  Congress “was well aware of how to grant an agency access to the courts to seek judicial enforcement of specific sanctions, including monetary penalties.”  Id. at 575.[1]

Since Fiero, at least one other court has extended the holding in Fiero to preclude an SRO from judicially enforcing its disciplinary fines.  See generallyNasdaq OMX PHLX, Inc. v. Pennmont Securities, 2012 WL 2877607 (Pa. Sup. Ct. July 16, 2012) (“Pennmont”).  In Pennmont, Nasdaq OMX PHLX, Inc. (“Nasdaq”) sought to judicially enforce a fine imposed under Exchange Rule 651 that its member firm – Pennmont Securities – refused to pay.  Id. at 2-4.  In ruling that Nasdaq could not commence a private action to collect on its disciplinary fine, the Pennsylvania Superior Court performed an analysis similar to that of the Second Circuit.  Id. at *16. 

Notably, the court held that Congress “was aware it could authorize judicial enforcement of monetary penalties imposed via disciplinary rules and regulations, including Rule 651,” but Congress “opted to remain silent about whether courts could enforce such monetary penalties.”  Id.  Thus, the court concluded that “we will not imply a private right of action to other sections of the Exchange Act that are silent.”  Id.

II.  Impact of Fiero on Insurance Coverage for SRO Investigations

A significant number of articles have been written about Fiero, noting that the decision “will not have a significant impact on member firms because the prospect of expulsion from the industry provides sufficient incentive to pay monetary penalties imposed by FINRA.”  See Second Circuit Rules FINRA Has No Power to Enforce Disciplinary Fines in Court, Nader H. Salehi (Oct. 6, 2011); see also Second Circuit Court of Appeals Rules FINRA Lacks Authority to Sue to Collect Fines, Joseph D. Simone (Oct. 17, 2011).  Fiero does, however, provide member firms an opportunity to access insurance coverage to protect against the costs of SRO investigations and proceedings.

D&O and E&O policies typically provide coverage for a “claim” (a “written notice, including service of suit or demand for arbitration, received by one or more insureds asking for money or services”) arising out of a “wrongful act” (“any negligent act, error, or negligent omission to which this insurance applies”).  Further, D&O and E&O policies typically provide a duty to defend if the suit seeks damages for loss “to which this insurance applies”: 

We will pay those sums that the insured becomes legally obligated to pay as damages . . . because of negligent acts or omissions committed in the scope of duties as a director or officer . . . which [occur] during the policy period to which this insurance applies. We will have the . . . duty to defend any ‘suit’ seeking those damages.

D&O and E&O policies, however, typically carve out fines from coverage:  “‘Loss’ shall not include . . . Fines or penalties imposed by law.” 

Insurers have argued that they have no obligation to indemnify their insureds for SRO fines and defense costs because any “fines or penalties” would be “imposed by law.”  However, with the issuance of Fiero and Pennmont, member firms have strong arguments that such “fines or penalties” cannot be “imposed by law.”  SeeFiero, 660 F.3d at 574; Pennmont, 2012 WL 2877607, at *16-17.  Moreover, member firms are in a much better position to argue that insurers are obligated to reimburse the member firms for defense costs until such time as a court concludes that SRO fines may be “imposed by law.”  See Fed. Ins. Co. v.Kozlowski, 18 A.D.3d 33 (N.Y. App. Div. 2005); Am. Home Assur. Co. v. Port Auth. of N.Y. & N.J., 66 A.D.2d 269, 278 (N.Y. App. Div. 1979). 

 III.  Member Firms Should Be Proactive In Determining Whether Insurance Coverage is Available To Avoid Out-of-Pocket Expenses

Given Fiero and Pennmont, member firms (especially in-house counsel) should act proactively to determine whether their current E&O or D&O insurance policies provide indemnity for SRO fines and reimbursement of defense costs.  In the event they do not, consider obtaining such coverage when renewing insurance policies.

In addition, if an SRO commences an investigation or proceeding, member firms should promptly provide notice of a potential claim to their insurers.  Failure to provide prompt notice may jeopardize a member firm’s insurance recovery.  Additionally, member firms should notify the insurer regarding the identity of the lawyers who will represent them in the underlying SRO investigation or proceeding.  Member firms should also provide regular updates of the activity in the underlying claim. 

Member firms need to be aware that the wheels of insurance are often slow to turn, and if an insurer denies coverage, that is not the last word.  Member firms should be ready to retain insurance coverage counsel to help guide them through the insurance process.


[1]              For a more detailed discussion of Fiero, please refer to FINRA and the Role of SROs in Enforcing the Securities Laws, 26A Sec. Lit. Damages § 26A:2.

Recent Ethics Charges Against Attorneys Demonstrate Need for Full Understanding of “Do’s and Don’ts” of Using Social Media As Litigation Tool

By Barry Buchman and Emily Grim

As we discussed in an earlier post regarding the use of social media to research potential jurors, the information available through social media can be a potent litigation tool. 

Indeed, far from being limited to a juror-research device, practitioners in the insurance realm and beyond are now using social media sites as a potential source of impeachment material for use against opposing parties or witnesses.  For example, counsel for an insured might attack the credibility of the insurer’s expert witness with evidence from Facebook or LinkedIn of the witness’s past professional or personal affiliation with the insurer or a competitor of the insured. 

 But, as recent ethics charges filed against two attorneys demonstrate, using social media in this fashion presents serious ethical considerations, just as it does when used for juror research.  As a result, it is essential that attorneys learn the boundaries of social media use and stay within them.  See M. Gallagher, Hostile Use of ‘Friend’ Request Puts Lawyers in Ethics Trouble, N.J. Law Journal (Aug. 30, 2012).

As with social media research in the juror context, there is little precedent on the ethical aspects of this issue, but the authority that does exist is in general agreement that lawyers can access publicly-available online information of any party or witness, even if the party or witness is represented.  The rationale is that if the online information is publicly-available (such as a public Facebook profile), it is no different than if the party or witness had published an article in print or online media.  See, e.g., N.Y. State Bar Assoc., Comm. on Prof. Ethics Op. No. 843 (Sept. 10, 2010).

As with jurors, however, the authorities also generally agree that lawyers may not seek to access non-public portions of a represented person’s social media accounts.  Moreover, also as with jurors, a lawyer may need to cease viewing even the publicly-available portions of these social media accounts if the represented party or witness learns that the lawyer is monitoring their online activity, as continued monitoring could be viewed as an attempt to intimidate or harass the party or witness.  Practitioners should be particularly mindful of this issue when searching sites such as LinkedIn, which show users the names of other site members who have viewed their profile.  And, lawyers who delegate this type of online research to paralegals or other non-lawyers should understand and convey these boundaries, as pleading ignorance of precisely how the research could be and was being conducted is risky.

Although a lawyer cannot seek to communicate directly with represented parties or witnesses by, for example, attempting to “friend” them on Facebook, a lawyer may do so with unrepresented parties and witnesses, but only if the lawyer does not use deception to obtain the online connection.  Most of the ethics opinions to address this issue have stated that the attorney must disclose both her true identity and the reasons for her connection request; i.e., the lawyer must not suggest that she is disinterested.  See, e.g., San Diego County Bar Assoc., Legal Ethics Comm. Op. No. 2011-2 (May 24, 2011).

Practitioners also can avoid the ethical risks associated with using social media to obtain informal discovery of parties and witnesses by serving requests for formal discovery of those persons’ online information.  For example, lawyers can serve direct discovery requests on other parties to the case or serve subpoenas on third-party witnesses.  Lawyers also may be able to subpoena social media providers to obtain information about a particular individual’s online accounts.  Courts generally have been receptive to such discovery requests.  See, e.g., Loporcaro v. City of New York, 2012 WL 1231021 (N.Y. Sup. Ct. Apr. 9, 2012).

Social media research in litigation can offer significant tactical benefits, but it also presents ethical risks.  Thus, it is important for practitioners to stay abreast of the law in this area, particularly given its rapid and continuing evolution.  Among other things, lawyers should know all pertinent procedural and ethical rules, including the procedures of the particular court and judge presiding over their case.  We will continue to monitor this topic closely in the coming months.

Importance of Cybersecurity Insurance

By Barry Buchman and Mickey Martinez

After two years of increasing and higher-profile cyber-security incidents, a new study has found that the issue of cyber-security risk is now one of the top concerns of corporate legal departments and directors.  See M. Stride, Data Security Now a Top Worry for GCs, Directors: Report, Law360 (Aug. 15, 2012).  We recently published an article on the potential availability of insurance coverage for losses arising from cyber-security incidents.   You can read the article here:  http://tinyurl.com/cad4oph.   

Commercial Insurance Policies Could Provide Protection for Businesses Facing Suits Under the Telephone Consumer Protection Act

By Barry Buchman

In one of the latest decisions to address the continuing debate over whether there is coverage under commercial general liability (CGL) insurance policies for so-called “blast fax” and “blast texting” lawsuits brought under the Telephone Consumer Protection Act (TCPA), a Wisconsin appellate court has ruled in favor of coverage.  See  Sawyer v. West Bend Mut. Ins. Co.,  2012 WL 2742291 (Wis. App. July 10, 2012).  In doing so, the court rejected the recurring insurance industry argument that CGL policies cover only invasion of privacy lawsuits that involve the alleged publication of the plaintiffs’ secrets; the court held that CGL policies also cover invasion of privacy lawsuits that allege a violation of the right to seclusion, i.e., the right to be left alone, which is typically the issue in “blast fax” and “blast texting” claims.

Although some commentators have suggested that decisions like this one likely will have no effect on disputes arising under newer CGL policies, which typically have TCPA exclusions, that is not necessarily so.

“Blast fax” and “blast texting” lawsuits frequently allege both statutory, TCPA claims and common law claims.  For the purpose of getting coverage at least for the costs of defending such lawsuits, as long as there is at least one covered claim or theory of liability, insurance companies often will have to pay all defense costs unless and until the policyholder is adjudicated liable only on the uncovered claims.  At least one court has issued exactly such a ruling in a dispute over coverage for blast fax claims in which the policies had a TCPA exclusion.  And, if the policyholder settles the lawsuit, there is, of course, never an adjudication of liability based only on the uncovered claims.  Thus, policyholders may be able to get coverage for such settlements, because it often will be difficult to establish that the policyholder settled the case solely due to concern about the uncovered claims.

Further, if an insurance company did not give proper notice to its policyholder of the addition of the TCPA exclusion to the CGL policy, that might provide a way around the exclusion as well.  And, other policies that an insured company may have, such as errors and omissions policies and directors and officers policies, may have exclusions that are narrower, i.e., that exclude less coverage, than the exclusions in CGL policies.

Thus, CGL and other commercial insurance policies continue to be a potentially very valuable source of protection for businesses facing TCPA lawsuits.  Businesses, therefore, should be willing to challenge coverage denials from their insurers if appropriate after an analysis of all of the circumstances, including the particular policy language and the particular underlying lawsuits.

Insurance Coverage for Wage and Hour Litigation Claims

By Barry Buchman, Kami Quinn, and Jason Rubinstein

There has been a surge in wage and hour litigation recently, and it has been getting a lot of attention.  See, e.g., M. Huisman, Seyfarth Shaw Study Shows Increase in Wage and Hour Labor Suits, Corporate Counselor (July 27, 2012); J. Segal, The New Workplace Revolution: Wage and Hour Lawsuits, CNNMoney (May 29, 2012).  This surge is due, in large part, both to the Great Recession and to technological advances allowing work from remote locations.  See P. Davidson, Overworked and Underpaid, USA Today (Apr. 16, 2012).

An often overlooked component of a company’s protection from the financial consequences of this type of litigation is its insurance policies.

Most employers, for example, routinely purchase employment practices liability (EPL) coverage.  This coverage typically exists either in separately-purchased EPL policies or, particularly with private companies, in directors and officers (D&O) insurance policies that include an EPL coverage component.

Yet, there is a common misperception that these policies do not cover wage and hour lawsuits.  Insurance companies have created this misimpression by relying on two principal arguments.  First, they assert that amounts expended in wage and hour claims do not constitute “loss” within the meaning of these policies because the claims seek only uninsurable restitution, and second, they argue that coverage is barred by the Fair Labor Standards Act (FLSA) exclusion often found in these policies.

Companies, however, should not accept these contentions at face value.

First, as with all coverage issues, the specific language of the policy matters. Some definitions of “loss” are broader than others, and some FLSA exclusions are narrower than others.

Second, the allegations of the particular wage and hour claims are important.  Plaintiff lawyers usually assert multiple claims and allege various theories of liability.  If even a single claim or theory is within the scope of coverage, the employer may be entitled at least to partial coverage.

Third, consistent with the two points above, several recent court decisions have cast doubt on the insurance industry’s principal arguments.  For example, in SWH Corp. v. Select Insurance Co., 2006 WL 2786930 (Cal. Ct. App. Oct. 19, 2006), the court denied the insurers’ request for summary judgment on whether the amounts sought in a wage and hour suit were “restitution,” and thus not “loss,” under the policy.  The court also found that the underlying allegations did not come within the policy’s FLSA exclusion.  Similarly, in California Dairies Inc. v. RSUI Indemnity Co., 617 F. Supp. 2d 1023 (E.D. Cal. 2009), the court found that the policy’s FLSA exclusion applied to some, but not all, of the allegations against the company.

Fourth, an insurance company’s duty to pay for its insured’s defense is broader than its duty to cover judgments or settlements.  So, even if it is ultimately determined that an insurer is not obligated to cover an underlying wage and hour settlement or judgment, the insurer may still be obligated to cover defense costs in the interim.  This “litigation insurance” can be very valuable, because wage and hour suits often proceed as class actions, and the costs of defending such actions can be very substantial.

Employers also should be aware that some insurers do offer specialty policies designed to cover wage and hour claims.  These policies, however, frequently cover only defense costs and contain low limits of liability.  Furthermore, insurance companies often erroneously market such products on the premise that there is never wage and hour coverage under EPL policies.  Thus, although employers should consider whether such specialty coverage makes sense for their business, they should still preserve and, when necessary, exercise their right to pursue coverage under their EPL policies, which typically have higher limits.  The specialty policies also can differ materially from each other, so a careful review of any proposed policy language is warranted.

Regardless of whether an employer is currently facing wage and hour claims, there are steps that all companies can take now to put themselves in the best position to potentially secure insurance coverage should the need arise.

First, collect, organize and safeguard all of the company’s policies.  This includes an effort to identify and obtain policies issued to other pertinent companies, such as predecessors and current or former affiliates of your company.

Second, consider having an insurance professional audit the organization’s insurance portfolio to confirm that the company has the most complete and cost-effective coverage available.

Third, if the company becomes aware of the possibility of a wage and hour lawsuit, or is actually served with one, it should, with rare exceptions, promptly notify its insurers.

In sum, the coverage provided by insurance policies for wage and hour lawsuits can be an extremely valuable corporate asset.  Companies can maximize the benefits of this asset by acting proactively now, and by being willing to question coverage denials from their insurers.