Lack of Separate Claims Examiners for Defense and Coverage Files Held to Warrant Estoppel Defense and Discovery Against CGL Insurer

CGL – ESTOPPEL – SINGLE ADJUSTER HANDLING BOTH DEFENSE & DJ FILES
U.S. Underwriters Ins. Co. v. Ziering
(EDNY, decided 5/28/2008)

Embedded within this discovery dispute decision is what I believe may be an "issue of first impression" or something new in the arena of insurance coverage in New York.

U.S. Underwriters disclaimed coverage to Ziering, its insured, for an underlying property damage suit that alleged damages caused by Ziering's construction activities near the underlying plaintiff's property. Underwriters provided a defense to Ziering in the underlying suit, however, and commenced this action for a judgment declaring that it was not obligated to either defend or indemnify Ziering in the underlying action.

In January 2008, the court granted Ziering's motion for permission to amend its answer to assert an affirmative defense of estoppel, arguing that it had learned that the same Underwriters' claims examiner was controlling both the underlying litigation and this one, to Ziering's harm. Ziering argued that because Underwriters did not erect a screen between those individuals managing Ziering's defense in the state court action and prosecuting Underwriters' claim in this action, Underwriters should be estopped from denying coverage. The court permitted Ziering to amend its answer to assert this defense.

Following that amendment, Ziering served discovery demands for: (1) Underwriters' litigation guidelines, manuals, etc.; (2) reports, correspondence, etc. from underlying counsel to Underwriters relating to the underlying property damage action; (3) reports, etc. from Underwriters to underlying counsel relating to the underlying property damage action; and (4) copies of relevant investigation reports. Underwriters objected to the demands as vague, overbroad, burdensome, irrelevant and improper, and as protected from discovery on privilege grounds. Ziering moved to compel responses.

In opposing that motion, Underwriters asserted that Ziering's real position is a claim that "no court has previously found to exist, namely, a purported failure to assign separate claims examiners for the coverage and defense aspects of the same claim file matter." Underwriters argued that such a claim is more akin to one for legal malpractice than to a true estoppel claim. The court, however, noted that "[w]hile the letter referenced by Underwriters' clearly states that it will provide Ziering with a defense in the Davis action "without waiving any of the grounds for disclaimer" set forth in the letter, it is far from clear that an estoppel defense can arise only when disclaimer is waived, as Underwriters claims."

In support of its motion, Ziering argued that Underwriters' articulation of the estoppel defense was entirely different from the actual defense Ziering was asserting. Ziering argued that it was not asserting that Underwriters had waived its right to disclaim coverage; instead, it sought to estop Underwriters from denying coverage because it allegedly "failed to, in good faith, properly consider, investigate and assess the claims against its insured when it provided a defense" in the Davis action. Ziering further contended that a liability insurer's duty to defend must be fulfilled, and is not satisfied merely by designating independent counsel. Thus, Ziering concluded, the internal claims procedure materials and written communications between Underwriters and underlying retained defense counsel were relevant to the estoppel defense because they pertained not to any malpractice claim, but to a breach of Underwriters' duty owed to its insured in providing a defense.

In rejecting Underwriters' argument that an estoppel can arise only where an insurer has waived its disclaimer rights, the court held:

While such a waiver may well give rise to an estoppel defense, there is nothing before the court to demonstrate that an estoppel defense could not arise under other circumstances as well. Here, Ziering is apparently arguing that Underwriters is estopped from disclaiming coverage because it has breached its duty to provide a zealous defense to Ziering in the Davis action. In response to Underwriters' argument that no court has found the use of a single claims adjuster to be improper, Ziering argues that the fact that "a single claims adjuster has acted as both the insured's prosecutor and defender renders the limited nature of the defense pursued by the insurer highly suspect," and provides some proof in support of the estoppel defense. Thus, Ziering does not claim that the use of a single claims adjuster is per se proof of breach of the duty to defend, only that it is some evidence of that breach, and enough to make the documents that they have demanded relevant. Much of the parties' argument goes to the merits of the estoppel defense itself, an issue that is not properly before this court now and cannot be decided at this time. Whether that defense proves to be meritorious or not, the documents requested by Zeiring [sic] are relevant to it, and cannot be withheld on that ground.

The court then went on also to reject Underwriters' argument that communications between it and retained defense counsel for Ziering in the underlying action were privileged from discovery:

[W]here an insured retains counsel to defend an insured in litigation, the attorney's paramount client is the insured. Therefore, to the extent that the interests of the insured and the insurer collide with respect to the assertion of the attorney-client privilege for communications with counsel retained for the insured, the insured necessarily prevails. (Citations and internal quotes omitted.)

The court found that since Ziering was the "paramount client", any privilege attached to the communications between Underwriters and retained defense counsel in the underlying property damage action was Ziering's, and Underwriters could not withhold production on that basis.

Although the court's earlier decision was merely to allow the insured to assert an estoppel defense based on Underwriters' use of a single claims examiner to monitor and handle both the defense (PD) and coverage (DJ) actions, the very fact that the court allowed such an amendment is potentially troublesome, especially to small insurers that may not have the staff to assign separate adjusters to parallel defense and coverage files. And just how far "up" must the screen extend? Past claim supervisors and managers? At some point, the claims decisionmakers cannot be separated.