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Evaluating mediation for coverage cases.

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Vol. 14, No. 9
October 1996
(:PR In\titute
fol- 1)ispute
Altrrnatives 107
Evaluating Mediation for Coverage Cases
By Harold J. Moskowitz 8c
David S. Sheiffer
Perhaps no commercial relationship is
more fragile than that of a policyholder and its insurer. Conceptually
the parties have inherently opposite
goals. Confronted with a claim, the
insured’s goal of maximizing coverage
is perceived to be in direct conflict with
the insurer’s goal of minimizing costs.
When a coverage issue arises, it adds
additional strain to the parties’ relationship.
Unfortunately, these perceived conflicts often overshadow extensive mutual interests that may weigh in Favor
of a negotiated resolution for coverage disputes. Mediation, with its inherent focus upon enabling the parties to
reach a mutually agreeable solution
built on common interests, offers the
parties a pragmatic alternative to the
time and expense of litigation.
Despite increased attention for alternative dispute resolution in recent
years, ADR use for insurance coverage
disputes has yet to achieve the level of
acceptance that it has for other commercial disputes. This is perhaps due
to the hostility of many jurisdictions,
including Arkansas and Florida, to the
use of binding arbitration for insurance disputes.
In contrast, many states already look
favorably upon mediation for various
types of insurance coverage disputes.
In certain types of coverage disputes,
mediation is mandatory in California,
Connecticut, Florida and Washington.
Given the common interest of a policyholder and insurer in successfully
defending a claim, the perceived
adversarial nature of the insurance rc-
lationship should not serve as a barrier
to mediated resolution of a coverage
dispute. This article, therefore, will focus on the Factors to be considered in
determining when an insurance coverage matter may be an appropriate candidate for resolution by nonbinding
mediation, and explore the common
concerns of both policyholders and
insurers that weigh in favor of a mediated resolution. Summary rejection of
nonbinding mediation invariably Fails to recognix
the talents of skilled mediators and the party’s ability
to negotiate in a focused
mediation forum.
When confronted with
aclaim, insurersand policyholders share the same
primary objective-that
the claim be resolved at
the lowest cost possible.
Focusupon thissharedoh
jective unfortunately can
‘be all too easily lost in the
face of a coverage dispute
as the parties seek to defend their individual concerns. This need not happen, however, if parties
understand the dynamics
of the insurance relationship and the
associated factors that favor mediation.
On one hand, the insurer, ifit immediately denies coverage or otherwise
forces the policyholder to obtain independent defense counsel, risks losing
control of the defense arid the corresponding expertise and economics
commonly associated with appointed
counsel. The insurer’s ability to control
settlement may be lost its well.
[Chmmonly when an insurer reserves rights on an indemnity issue that
may give rise to a conflict if the insurer
controls the defense, a policyholder is
free to retain independent counsel at
the insurer’s expense. And if an insurer denies coverage, the insured is
free to enter a reasonable settlement
without the need for the insurer’s consent-although if‘ the insurer pays defense costs its consent to settlement
may be required.]
On the other hand, faced with a
coverage dispute a policyholder may
be forced to immediately expend its
resources to defend the claim, and
possibly litigate a declaratory judgment action. Moreover, even if the
policyholder ultimately should prevail
on the disputed coverage issue, attorneys fees incurred in a declaratory
judgment action are not always recoverable, and the insurer’s liability is lim-
Insurers and
policyholders share
the Same primary
claim be resolved at
the lowest cost
ited only to reasonable defense costs
and to a reasonable settlement. What
is “reasonable” also presents a litigation question.
[Generally, if there is a coverage dispute an insurer should defend subject
to a reservation of rights and cornmence a declaratoryjudgment action
to determine coverage. Commercial
Union Ins. Co. u. Intrmntional~lauorsand
FraLgranrrs,822 F.2d 267 (2d Cir. 1987).
Only ifthe insurer has cast the insured
in a defense posture by wrongfully refusing to defend a claim can the policyholder recover attorneys fees; the
costs of a declaratoryjudgment action
are not otherwise recoverable. 17mfiloym Mut. Ins. Co. v. Kqy I’hnrmncxutirals,
75 F.3d 815 (2d Cir. 1996). Even ifthe
denial is wrong, recovery is limited to
reasonable defense costs and settlement payments.]
( c o n t i n i d on f i q r 113)
Vol. 14, No. 9
Ortoher 1996
CPK Institulr tor Lhsputr R r ~ o l i i t i o i i
Evaluating Mediation for Coverage Cases
(continued from page 107)
Regardless of the perspective, and
given the obvious costs to both parties,
an early resolution for coverage disputes provides benefits for all concerned. The question, however, is how
best to reach an early compromise.
There are several generally applicable factors that encourage the use
of mediation for coverage disputes.
Mediation generally is a cost-effective
alternative to litigation. Mediation may
preserve relationships, unlike the combat of litigation, which is a particularly
important in an insurance setting involving others, including other insurers or brokers, that may be affected by
a coverage dispute.
Unlike court-ordered ADR or mediation, private mediation is not subject to public scrutiny. A high proportion of disputes submitted to
mediation are settled, generally in a
relatively short time.
In short, mediation serves the dual
purpose of reducing costs while maintaining the common objective of resolving the underlying claim in a
mutually agreeable fashion.
While mediation generally is less expensive than litigation, it is only cost
effective if the dispute is an appropriate candidate for a negotiated resolution. Mediation may not be appropriate
in at least three typical scenarios: where
the disputed issue involves a controlling
point of law for which a party may wish
to establish judicial precedent; if one
party has a strong legal and factual position, it may favor ajudicial resolution
that will lead to ajudgment in its favor
without a compromise; or where a party
does notwant to settle for strategic reasons, such as the impact a settlement
may have on other claims, or encoiiraging new claims.
Insurer needs for a binding judicial
o r arbitration o r d e r also may be
present because of reinsurance concerns. The fact is that in federal litigation more than 90% of cases ultimately
settle, and early evaluation of settlement through mediation is thus an
economic choice.
Below are factors to evaluate before
submitting a coverage dispute to me-
diation. They are: the question of defense obligation under the type of
claim and coverage; the involvement
of other insurers or brokers; interim
solutions; extra-contractual exposure;
and other implications. These factors
help in the ultimate decision, the
evaluation of litigation or arbitration
as compared to mediation.
Defense Obligation/Type of
Coverage Question
The rule that the duty to defend is
broader than the duty to indemnify is
now uniformly accepted throughout
the U.S. An insurer will incur defense
costs if there is even a remote possibility of coverage. (For example, see Villa
Charlotte Bronte, Inc. 71. Commercial Union
Ins. Co., 64 N.YPd 846,848,476N.E.2d
640,641,487N.YS.2d314,315 (1985).)
Even if an insurer contends the policy
should be rescinded because itwas procured through misrepresentation or
fraud, an insurer with a primary coverage obligation can be required to fund
interim defense costs to allow the uii-
lution of the insurer’s duty to indemnify,thereby permitting the insured to
seek summary judgment immediately
on the defense obligation. Marc S.
Mayerson, Insurance Recovery of Litigation Costs: A PrimerFor Poliqholders and
7hPir Counsel, 30 Tort & Ins. LJ. 997
(Summer 1995).
Thus, the fact that an insurer faces
the prospect of paying both defense
costs and the costs of a declaratoryjudgment action call for an early resolution
of a coverage dispute, one that might
only be achieved without litigation.
Aside from the initial expense of litigating a coverage action, an insurer
also must consider the evidentiary
burden it may face in litigation. For
instance, if an ambiguous policy provision is at issue, will the rule of contra
proferentum-requiring that as a matter of law ambiguous policy language
is construed against the insurers-be
applicable? Might evidence of underwriting intent be needed? If so, is there
an internal concern that underwriting
guidelines or the underwriting file not
The fact that an insurer faces the
prospect of paying both defense
costs and the costs of a declaratory
judgment action call for an early
resolution of a coverage dispute.
derlying litigation to proceed pending
resolution of the coverage dispute. See
Nalional UnionFireIns. Co. u.Sahlun, 999
F.2d 1532, 1535 (11th Cir. 1993).
The fact then that an insurer will
likely incur defense costs from the onset of a claim favors early resolution of
any corresponding coverage dispute.
If determination of the coverage issue depends on facts to be resolved in
the underlying litigation, such as
where a policy exclusion is at issue,
initial litigation costs also may weigh
in favor of a mediated resolution.
Courts increasingly have stayed reso-
be produced, or that the underwriter
will not make a favorable witness? Does
the insurer face the prospect of disclosing similar coverage disputes that may
have been resolved against its interests?
Evaluation of these considerations may
then favor mediation if a weak spot in
pursuing an action may exist.
A policyholder, like the insurer, also
must evaluate coverage litigation costs
and its evidentiary burden. If the dispute involves an insurer’s refusal to
defend, the policyholder also must
shoulder defense costs, often without
(continued on follon~ingpage)
114 Alternatives
Mediation for
Insurance Cases
(continued from previous page)
the insurer’s ready ability to appoint
counsel with necessary expertise in
defending the type of claim involved.
Even if it is clear the insurer’s decision not to defend is untenable, the
policyholder must act with prudence
and caution in defending the claim.
Even though the insurer potentially is
liable for reasonable defense costs and
settlement, a policyholder may not ignore the implied covenant of good
faith and enter a collusive settlement
with an eye to then seeking recovery
from the insurer.
Involvement of Others
A coverage dispute is not necessarily
restricted to the policyholder and insurer involved, but also may affect
other insurers and a broker. If the dispute ultimately is resolved in the
insurer’s favor, the result also could
mean a n e r r o r o r omission claim
against the broker. Other insurers, regardless if they are a co-insurer or excess insurer, also potentially are
affected either by having to shoulder
the defense alone or paying a greater
share of the loss.
Since all of the potentially affected
parties presumably have a common
interest in continuing the existing business relationship, this is yet another
factor favoring mediation. Mediations
involving continuing business relationships generally have a higher success
rate than those that do not.
Perhaps the most viable coverage
dispute for resolution by mediation
is that where multiple insurers are involved. Inter-insurer disputes generally take several forms: claims where
multiple insurers cover all o r part of
the same risk; “other insurance” disputes involving the proper allocation
of defense cost and loss among insurers with the same coverage; and
excess-primary insurer disputes. Yet
absent an expedited resolution by
mediation or otherwise, as the insurers dispute their coverage obligations, the policyholder is often left
to fund its own defense.
Vol. 14, No. 9
CPR Iiistitutr for Dispute Resolution
One consideration favoring mediation of multiple party disputes is that
even if several insurers are involved
and only one disputes coverage, that
insurer nevertheless may be required
to fund the insured’s defense costs
despite the existence of other coverage. This is particularly true in pollution or toxic tort cases where multiple
insureds and insurers are involved,
and one primary carrier is targeted
by the insured to shoulder its defense.
Given the significant costs to be incurred in connection with pollution
and toxic tort coverage actions, turning initially to mediation rather than
litigation is an increasingly attractive
option, particularly since some coverage-claim mediations in the ares have
been successful. See Krnneth R.
Feinberg, Mediation -A Preferred
Method Of Dispute &.solution, 16 Pepp.
L. Rev. S5 at S42, n. 17.
Apart from the direct business irnplications a coverage dispute may have
upon both the policyholder’s a n d
insurer’s relationships with a broker,
the broker’s involvement in mediation
efforts also should be considered for
several pragmatic reasons.
First, a broker’s participation in negotiations for
the policy may preclude
application of the contra
proferentum rule. See
Werner InrluJtrws, Inc. u.
Fzrst Slate Ins. Co., 1 12 N,J.
30,548 A.2d 188 (1988).
Second, if the broker
supplied the policy language, it may not only
avoid application of contra proferentum, but i t
also raises the prospect
liability being imposed
upon the broker as well.
Ortobrr IWF,
nation of policy language adverse to the
insured. This concern also may exist
where there is a dispute concerning a
gap in coverage between primary and
excess policies, where the broker may
become a focal point as the parties seek
to avoid responsibility for a gap. The
broker’s inherent interest, therefore,
may point toward mediation.
Interim Resolutions
Mediation may not be accepted by all
parties as an appropriate vehicle to
resolve a coverage dispute. In such a
situation, one might consider what
interim solutions may be employed.
Where one party is reluctant to mediate because of a fear of a lengthy
proceeding, it is simple enough to
agree that a time limit of, for example,
60 days be imposed on a mediation
effort. Similarly, if there are concerns
that a limitations defense might preclude litigation ifsuit is not filed soon,
then a tolling agreement might be
considered. If the insured is reluctant
to mediate because any legal fees incurred may not be a covered expense,
the insurer might consider either pay-
A Coverage dispute
is not necessarily
restricted to the
policyholder and
insurer involved,
but also may affect
other insurers
Vol. 14, No. 9
October 1996
Extra-Contractual and
External Concerns
With the ever increasing threat of badfaith claims, insurers also must consider the adverse impact of forcing
litigation of a questionable coverage
issue. If the insured lacks the financial
strength to defend a claim where there
are disputed coverage issues, there
exists a real prospect of a viable badfaith action. See Phelan, TheFirst Party
Dilemma: Bad Faith or Bad Business?, 34
Drake L. Rev. 1031, 1035-1036. Conversely, an insured should carefully
evaluate its coverage position, since a
frivolous defense or complaint could
result in court-imposed sanctions and
an award of attorney’s fees in favor of
the insurer.
Insurers also should consider that
negotiated coverage-dispute resolutions might be employed as evidence
of inconsistent coverage determinations of an ambiguous policy provision
in a bad-faith action. There also is the
practical concern if the court in the
action underlying a coverage dispute
will permit the use of special interrogatories to the jury at trial necessary to
resolve fact-dependent disputed coverage questions. This could spark coverage litigation even after trial of the
underlying claim.
Bad faith concerns also exist where
there is an excess insurer involved, and
the primary insurer fails to settle a
covered claim with the primary policy
limits. Therefore, efforts to mediate
the extent of a carrier’s coverage obligations before settlement pressure
arises should be considered.
Other Implications
Additional questions that may affect
the decision to seek mediation may not
have immediate legal or business consequences. For instance, both insurers
and policyholders should consider that
an adverse decision on a disputed coverage issue could affect other cases.
Adverse precedent on an evolving legal issue often goes beyond a particular case to affect an entire class of
Such concerns, for example, in professional or products liability,can hurt
the interests of both policyholders and
insurers. One gray area is the ever in-
CPR Institute for Dispute Resolution
creasing coverage litigation concerning sex abuse claims for medical professionals. Although a majority of
courts have rejected such claims as not
involving professional services, a minority have adopted the view that if the
abuse occurs during treatment, cover-
Alternatives 115
age exists. In certain circumstances,
however, even courts adopting the
majority view have found that there is
a duty to defend. See generally David
F. Florig, Insurance Coveragefor Sexual
Abuse or Molestation, 30 Tort & Ins. L.J.
(continued on back page)
Spotlight on ADR Use
(continued from page 106)
recover our payments. But more recently, we have concluded that litigation is far too slow and too expensive.
Why not, we reasoned, resolve these
subrogation claims through ADR?
Thanks to such forward-thinking
manufacturers as Whirlpool Corp., we
have entered into highly successful
global agreements. At the core of this
program was the invaluable support we
received from CPR. It was through
CPR that State Farm was able to identify and approach corporations who
shared a similar commitment to ADR.
At State Farm, we think we havejust
scratched the surface of ADR applications. Pre-suit mediation offers tremendous potential and is garnering
acceptance from both the plaintiff‘s
and defense bar. It is encouraging to
see the legal profession and corporate
America embrace the same goal of fair,
inexpensive and speedy resolution of
disputes. After all, it’s what our clients
and customers truly want.
Richard W. Simmons
Associate General Counsel
NationsBank Corp.
Alternative dispute resolution came of
age for us when the Texas operating
subsidiaryof NationsBank had to manage the growth of litigation arising
from the ashes of the First RepublicBank operating entities closed by the
FDIC in 1988. Texas proved to be the
ideal testing ground for mediation and
arbitration, especially due to the state’s
well developed court sponsored mediation program. The Texas experience overwhelmingly confirmed the
strategic advantages of using mediation and arbitration, both of which
were incorporated in NationsBank’s
standard commercial and real estate
contracts. Despite this success, we still
hear from a vocal minority of outside
counsel in a few states who question
whether ADR is in the best interest of
the client.
Since the Texas experience, NationsBank has incorporated two-step mediation and arbitration in its Customer
Connection Accounts and dealer-finance agreements. Additionally, alternative dispute resolution mechanisms
have been used in the company’s
merger and acquisition documents,
fiduciary areas and vendor contracts.
We are continually surprised and
gratified to witness our executives
embracing ADR and investigating avenues for its further extension within
the corporate environment. Over the
past six years it has been rare to encounter an executive who has not
been associated in some way or another with ADR. Out of the number
of claims resolved annually, approximately 15% are resolved directly
through ADR or as a result of an attempted mediation that enabled parties to quickly thereafter negotiate a
mutually satisfactory resolution. This
experience has led NationsBank to
initiate discussion groups to evaluate
using mediation and arbitration for
its consumer products.
Along with ADR’s satisfying results
and the significant savings on human
resources and costs, ADR’s most important contribution has been facilitating early and open dialogue
between the parties which promotes
early resolution of their differences.
This material is adapted from a n interuiew
by CPR Institute for Dispute Resolution
PresidentJames Henry, which appeared in
Metropolitan Corporate Counsel i n
August 1996.
116 Alternatives
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Vol. 14, No. 9
October 1996
Insurance ADR
(continuedfrom preuious p a p )
699,721-731 (Spring 1995). Ifthe coverage question concerns an evolving
or gray area of law, then a mediated
resolution may prove a viable option
to litigation.
Admittedly not every coverage dispute
is a candidate for mediation. When
weighing the decision to mediate, the
cost of litigation for insureds and insurers alike certainly tips the scale in
favor of mediation in the first instance.
The simple fact is that in many ways
the decision to mediate insurance coverage disputes is a simple one, given
the time, costs and uncertainties becoming embroiled in litigation or arbitration may hold.
Perhaps the adage “Nothing ventured, nothing gained” should be the
paramount guiding principle in determining to seek mediation ofinsurance
coverage disputes. It is one that all
parties to the insurance relationship
certainly can embrace.
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