What Employers Need to Know About

EMPLOYMENT LAW ISSUES:

WHAT EMPLOYERS NEED TO KNOW ABOUT

INSURANCE FOR EMPLOYMENT LITIGATION

(SLIDE PRESENTATION)

Ann Kane Smith

Greenberg Glusker Fields Claman & Machtinger, LLP

MARCH 2000

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TABLE OF CONTENTS

Page

I. INTRODUCTION 1

II. PUBLIC POLICY ISSUES RE: COVERAGE FOR

EMPLOYMENT PRACTICES LIABILITIES 1

III. VARIATIONS IN EMPLOYMENT PRACTICES LIABILITY POLICIES 6

IV. THE INSURER’S DUTY TO DEFEND AND THE INSURED’S DUTY TO CO-OPERATE IN THE INVESTIGATION AND SETTLEMENT OF A CLAIM 10

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I. INTRODUCTION

Employment litigation is not new to California employers. What is relatively new is the insurance industry’s development of products to insure against these risks. This paper is intended to provide some practical guidance to employers contemplating employment practices liability insurance. It is not intended to provide a detailed discussion of the coverage issues which frequently arise under such insurance policies.

II. PUBLIC POLICY ISSUES RE: COVERAGE FOR EMPLOYMENT PRACTICES LIABILITIES

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Generally speaking, Workers Compensation policies cover the employer’s obligations under state law for employee injuries arising out of and occurring during the course of employment. In California, Worker’s Compensation is a statutory no fault system, and imposes liability on the employer to pay for temporary and permanent disabilities, medical and rehabilitation expenses, death benefits and lost wages if the employee is injured in the course and scope of his employment. In exchange, the employer is relieved from common law tort liability for personal injuries to the employee caused by the employer’s negligence. California Labor Code §§ 3601, 3602 and 5300.

However, an employee’s claim that the employer violated federal and state anti-discrimination statutes, or wage and hour laws, or a fundamental pubic policy, or committed other intentional torts will not be barred by the exclusive remedy provisions of California’s workers compensation statutes. La Jolla Beach & Tennis Club v. Industrial Indem. Co., 9 Cal.4th 27 (1994). Rather, an employee can also sue for such violations and, if successful, can recover damages in the form of lost wages and benefits, compensatory emotional distress damages, attorneys fees and costs, and in some cases fines, penalties and punitive damages. In such cases, in order to prevail, the employee must prove that the employer’s actions were intentional or willful. Texas Dept. of Community Affairs v. Burdine, 450 U.S. 248 (1981); St. Mary’s Honor Center v. Hicks, 509 U.S. 502 (1993).

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It is this expanded liability that most employers are seeking to insure against. However, there is a strong public policy which bars insurance indemnification for a person’s intentional or willful misconduct. The general rule is that “a contract of insurance to indemnify a person for damages resulting from his own intentional misconduct is void as against public policy and courts will not enforce such a contract.” Dixon Dist. Co. v. Hanover Ins. Co. 641 N.E. 2d 395, 401 (Ill. 1994). In California this rule is codified in Insurance Code § 533 and Civil Code § 1668.

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The leading California case to address this public policy issue in the employment context is Coit Drapery Cleaners Inc. v. Sequoia Insurance Co., 14 Cal.App.4th 1595, 18 Cal.Rptr.2d 692 (Cal.App. 1 Dist. 1993). In that case, the employer sued its insurance carrier for breach of contract for the insurer’s failure to defend and indemnify the company against an employee’s claims of sexual harassment and wrongful termination. The court held that sexual harassment and wrongful termination were intentional acts which were excluded by the terms of the employer’s commercial general liability insurance policy, and for which insurance coverage was barred by California’s Insurance Code § 533 prohibition against coverage for willful acts. The court noted that: “One does not, for instance, try to force an unwilling subordinate employee to the floor for intercourse, or fire her for refusing sexual favors, as a result of mere negligence.” The court explained that pursuant to Insurance Code § 533, “California law and applicable precedents do not allow the recharacterization of such clearly intentional and willful sexual misconduct as merely negligent or nonwillful, so as to trigger insurance coverage” (citations omitted). Id. at 1603.

The prohibition found at Insurance Code § 533 is implied into every contract of insurance. J.C. Penney Cas. Ins. Co. v. M.K., 52 Cal.3d 1009 (1991).

Other courts have reached similar results in cases involving claims of wrongful termination and employment discrimination finding that there is a strong public policy which prohibits the shifting of liability to an insurance carrier for an employers’ intentional wrongs. Allstate Ins. Co. v. Tankovich, 776 F.Supp. 1394 (N.D. Cal. 1991). The argument that the employer was simply negligent in its supervision over the errant employee wrongdoer who acted outside his or her authority will not trigger insurance coverage for the damages or injuries the employee suffered from the intentional act. Courts have found that the employer’s general intent to commit an act which is inherently harmful, rather than any specific intent to cause harm to the victim, is sufficient to preclude coverage. American Guar. & Liability v. Vista Medical Supply 699 F.Supp. 787 (N.D. Cal. 1988); B&E Convalescent Center v. State Compensation Insurance Fund 8 Cal. App. 4th 78, 9 Cal. Rptr. 2nd 894 (1996).

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Under California law, punitive damages are awarded as a deterrent for malicious or oppressive acts. Given that purpose, it is against California’s public policy to allow an employer to insure against an award of punitive damages. PPG Industries v. Transamerica Ins. Co., 20 Cal.4th 310 (1999).

Although California law has prohibited this type of insurance, the insurance industry is nonetheless offering employers employment practices liability insurance (“EPLI”) which expressly covers intentional acts, including sexual harassment, discrimination and wrongful discharge in violation of public policy. Employers are purchasing such policies in order to better manage the risks of employment litigation. Employers should be aware that such EPLI policies and their coverage terms have not yet been tested by the courts, and ultimately employers may be unable to enforce their rights to indemnification of liability under such insurance contracts if any dispute arises.

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While public policy, Civil Code § 1668, and Insurance Code § 533 may preclude indemnification of liability for intentional wrongs, an employer may still be entitled to indemnification for the costs of defending against such claims, depending upon the facts in each case. Melugin v. Zurich Canada, 50 Cal.App.4th 658 (1996).

III. VARIATIONS IN EMPLOYMENT PRACTICES LIABILITY POLICIES

There are many insurance companies, large and small, offering EPLI insurance, and there are significant variations in coverage. Leading insurance carriers are now offering coverage for the following employer conduct:

a. All forms of employment discrimination, including harassment and retaliation; and,

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b. Wrongful Employment Decisions/Acts defined as: actual or constructive termination, wrongful demotion, wrongful evaluation or discipline, failure to hire, failure to promote, negligent administration of human resources policies and procedures, promissory estoppel, intentional interference with contract, misrepresentation, personal injury caused by libel/slander, intentional infliction of emotional distress, humiliation, invasion of privacy, violation of public policy terminations, violations of family medical leave act, civil rights violations, failure to grant tenure, failure to make partner, failure to make shareholder, negligent hiring, negligent supervisor, and retaliation connected to whistleblowing).

Typically, there is no coverage for conduct which occurred outside the policy period. Other common exclusions from EPLI coverage are:

a. National Labor Relations Board proceedings;

b. claims arising from strikes or lockouts;

c. WARN Act violations;

d. COBRA violations;

e. Wage & Hour violations;

f. Employment Retirement Income Security Act (“ERISA”) claims for benefits or for breach of fiduciary duties;

g. incidents of workplace violence;

h. class actions;

i. Worker’s Compensation claims;

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j. claims for breach of a written contract for employment; k. downsizing or restructuring of an organization or entity;

l. alleged criminal conduct; and

m. claims for breach of collective bargaining agreements.

Covered “losses” generally include awards or settlements for:

Ø Front Pay

Ø Back Pay

Ø Insurance Benefits

Ø Punitive Damages

Ø Liquidated Damages

Ø Claimant’s Statutory Costs and Attorneys’ Fees

Ø Defense Costs

However, civil or criminal fines or penalties, amounts owed under local or state wage and hour laws, bonuses, commissions, salary and benefits amounts in a written contract, and profitsharing benefits are usually excluded from the definition of covered losses.

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Whenever an employer is confronted with an employee’s claim or lawsuit, it should review its current insurance policies to determine what coverage it may have for employment related risks. Commercial General Liability policies, Errors and Omissions policies, Directors and Officers liability policies and Worker’s Compensation policies may cover some employment related claims. While such policies may cover some risks, it is likely there will be gaps in coverage. Nevertheless, the employer should immediately tender the claim or the lawsuit to its insurance carriers. If the employer has EPLI insurance, it is likely that the insurer will accept the tender for at least some of the claims.

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IV. THE INSURER’S DUTY TO DEFEND AND THE INSURED’S DUTY TO CO-OPERATE IN THE INVESTIGATION AND SETTLEMENT OF A CLAIM

Liability insurance imposes two separate obligations on the insurer: (i) to indemnify the insured against claims covered by the policy, and (ii) to defend such claims against its insured.

The duty to defend is broader than the duty to indemnify. The insurer may owe a duty to defend claims that are potentially covered under the policy, including groundless, false or fraudulent claims, claims for which the insured reasonably expects coverage and any lawsuit in which any claim is covered or potentially covered even if others are not.

Whether there is a duty to defend is determined at the outset of the litigation. It depends upon the terms of the policy, the allegations of the complaint/claim and the facts known to the insurer from any source. Montrose Chem. Corp. v. Sup. Ct., 6 Cal.4th 287 (1993) [Canadian Universal Ins. Co., Inc.]

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The insurer has the choice of (a) refusing the insured’s tender of the claim; (b) accepting the insured’s tender of a claim without raising any objection to coverage; or (c) defending on a “reservation of rights” basis.

If the insurer refuses to defend, it loses control of the defense, it is not entitled to any notice of developments in the litigation, and it will be bound by the issues litigated.

If the insurer accepts the tender of the claim unconditionally it forfeits the right to challenge coverage later.

By accepting the defense without reservation, the insurer will have the right to control the defense and settlement of the claim.

If the insurer undertakes defense of a third party lawsuit, it must employ competent counsel to represent the insured and provide such counsel with adequate funds to defend the suit.

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The counsel must be competent to defend the particular matter at issue. Travelers Ins. Co. v. Lesher 187 Cal.App.3d 169, 186. In employment cases, this rule generally requires the insurer to retain experienced employment litigation counsel.

An insurer is generally not liable for its appointed lawyer’s mistakes or negligence. The remedy for such malpractice lies against counsel, not the insurer. Merritt v. Reserve Ins. Co., 34 Cal.App.3d 858, 882 (1973). But see Travelers Ins. Co. v. Lesher, 187 Cal.App.3d 169, 186 (1986).

The insurer must also adequately fund the defense. Problems arise where there is a disagreement between the insurer and counsel when the insurer wants to limit the case preparation, e.g., limiting the number or length of depositions, expert witnesses, etc. If there is no potential risk of adverse consequences to the employer, it is the insurer’s problem if it limits the preparation of a defense. But if there is a potential adverse impact on the employer, it may become a more significant issue and could create a conflict between the insured and the insurer which would require counsel to withdraw and the insurer to retain independent counsel for the insured.

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The insurer cannot unilaterally terminate its duty to defend while the insurer is at risk of an adverse judgment.

The duties of defense counsel employed by an insurer to defend a claim without any reservation of rights are as follows:

1. Counsel is deemed to have an attorney-client relationship with both the insurer and insured. State Farm Mut. Auto Ins. Co. v. Federal Ins. Co., 72 Cal.App.4th 1422 (1999).

2. The clients’ written consent is not required when attorney jointly represents insured and insurer because no potential conflicts exists.

3. Although counsel has fiduciary duty to both the insured and insurer, the primary duty is to the insured. Purdy v. Pacific Auto, 157 Cal.App.3d 59 (1984

4. The Attorney-Client Privilege is held jointly by insurer and insured, Counsel’s duty to protect client confidences may create conflicts later requiring withdrawal. Cal. State Bar Form Opn. No. 1995-139.

5. Counsel is obligated to communicate settlement offers and to advise the insured about potential consequences of an adverse verdict.

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6. Counsel is obligated to communicate settlement offers and to advise the insured about potential consequences of an adverse verdict.

7. If actual conflict of interests arises, informed written waiver and consent to representation is required. California Rules of Professional Conduct, Rule 3-310(c)-2. Betts v. Allstate Ins. Co., 154 Cal.App.3d 688 (1984).

8. Examples of actual conflicts which arise between insured and insurer are:

a. Covered and non-covered claims in same lawsuit;

b. Potential liability to insured in excess of policy limits;

c. Prejudicial settlement terms to insured;

d. Conflicts among jointly represented interests due to their divergent views on liability and litigation tactics;

e. Conflicts based upon client confidences.

Employment litigation often involves these conflicts of interests, and it is not at all uncommon for counsel to point out these risks to the employer before the claim is tendered to the carrier.

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If the insurer believes that there is a potential coverage issue, or a potential conflict between the insurer and the employer, it may accept the tender of the defense subject to its reservation of rights.