You are in-house counsel for a manufacturing company with a

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1 The First Wave of Decisions Interpreting Employment Practices Liability Policies By Barbara A. O Donnell You are in-house counsel for a manufacturing company with a national sales and distribution force aided by more than 150 employees and independent contractors. Over the past 20 years, the company has grown from a small operation, manufacturing only one product, to a midsize company offering a wide range of customized widgets. Today, Susan Brown, the vice president of sales, submitted a letter of resignation. In it, Susan claims that she has been forced to leave because the recently hired CFO has been edging her out by shifting several of her key responsibilities to Joe, the regional sales director who accompanied the CFO when he joined the company, and by excluding her from strategic decisions and important client meetings. Susan insists that the CFO embarked on his efforts to force her out after she complained about his implementation of what she views as questionable accounting practices. Susan also claims that the new bonus structure, implemented about a year ago, violates the incentive compensation terms contained in the employment contract she signed in 1991, when she first joined the company. The president of the company is concerned that Susan will sue. He wants you to investigate and line up supporting witnesses. He also wants to know if the company has insurance coverage for her suit. What do you tell him? Variants on this situation have become increasingly prevalent over recent years. An explosion of employment practices liability claims presenting some combination of the constructive discharge, whistle-blower, retaliation, discrimination, contract, and statutory claims alluded to above led the insurance industry to develop employment practices liability insurance (EPL) to meet the heightened risks that small and large companies now face. Before the arrival of EPL, employers sought coverage under their existing general liability insurance, directors and officers liability insurance (D&O), workers compensation, and employer s liability policies for protection against employee suits. More often than not, these traditional sources of insurance coverage proved inadequate when applied against the broad range of claims and damages sought in employment practices claims. Designed to fill the gaps left by other types of coverage, EPL policies provide employers with a broad range of defense and indemnification coverage for the most prevalent types of discrimination, retaliation, and wrongful discharge claims brought under common-law and statutory theories, subject to 1

2 potential exclusions for certain types of relief, such as punitive damages, fines, or penalties. Over the past decade, more and more employers have added EPL to their insurance portfolio. The increasing reliance on EPL appears justified. The Equal Employment and Opportunity Commission (EEOC) reports that it received 79,432 new Title VII, Americans with Disabilities Act, Age Discrimination in Employment Act, and Equal Pay Act charges in fiscal year and awarded monetary benefits totaling $168.1 million during that year. 2 Even though EPL has gained widespread use, the policy forms continue to vary in important respects with the result that employers and their advisors must carefully review the EPL policy in conjunction with any other sources of insurance to ensure that coverage for the specific types of risks faced by that business is as comprehensive as possible. In the scenario above, for example, the company s EPL policy would probably provide defense and indemnification coverage for any retaliation, constructive discharge, whistle-blowing, and gender discrimination claims but might not cover the contract claim, depending on whether the EPL policy contains a common exclusion for breach of contract claims. Even if coverage was available for the range of claims posed by this scenario, the policy might contain limitations on the type of relief covered and might exclude (or provide sublimits for) an award of punitive damages. What if Susan sought to recover the value of stock options? How would coverage vary if the claims were brought by, or against, an independent contractor rather than an employee? What obligations would the insurer have if the company delayed in providing notice of Susan s claim, perhaps because it wanted to negotiate a separation agreement with her? What if the company knew of the potential exposure to claims arising out of its accounting practices when it applied for EPL but replied none when asked in the insurance application to disclose any circumstances that might be reasonably expected to give rise to claims. As with any other form of insurance, disputes over the scope and meaning of EPL policy provisions and exclusions are inevitable. Because EPL insurance remains relatively new, however, courts and practitioners have had to rely on decisions concerning other types of policy forms when addressing disputes under EPL policies. With EPL insurance now gaining widespread use by companies of all sizes across a host of industries, courts are starting to adjudicate disputes under these types of policies. By reviewing these decisions, employers, their counsel, and risk managers can gain useful insights into important ways to avoid significant coverage gaps and maximize the protections offered by EPL policies. While there may be no surprises in the emerging body of EPL decisions for those familiar with coverage doctrines developed through judicial interpretation of D&O or other types of wrongful act or errors and omissions policies, it is useful to examine how courts apply these concepts when interpreting EPL policy terms, conditions, and exclusions. Basic EPL Insuring Clause Disputes Insurers offer a wide range of EPL products, with options to purchase a stand-alone policy offering more comprehensive protections or an endorsement to D&O or other policy forms that may offer more restricted coverages. Businesses whose employees frequently deal with third parties, including customers or vendors, outside of the workplace can purchase third-party endorsements that extend EPL coverages to harassment or other claims arising out of the employees interactions with these third parties. Companies that depend on nontraditional workers, such as independent contractors or consultants, need to make sure their policy encompasses claims by and against these persons. Given these variations, it is not surprising that several EPL decisions concern disputes over the scope of the basic coverage grant or insuring clause in the applicable policy form. The dispute in Peoples Mortgage Corp. v. Kansas Bankers Surety Co. 3 concerned an EPL policy purchased in 1999 that covered related banking entities in Kansas, Colorado, and New Mexico. The policy s liability limit was $250,000 for all loss, including defense costs. Using novel language drafted by the insurance company president and vice president, the policy stated that the insurer would defend and indemnify the bank for up to a maximum of one year of claimant s salary which the Bank is legally obligated to pay by reason of any actual or alleged Wrongful Act arising out of the Employment Claim first filed against the Bank during the Policy Period. 4 The policy defined employment claim to include civil or arbitration proceedings brought by past or present employees for any wrongful act, as defined, in connection with an 2

3 actual or alleged wrongful dismissal, breach of a verbal or written employment contract, workplace harassment, failure to promote, or wrongful discipline. The bank sought coverage for $175,000 paid to settle a lawsuit brought by a former employee, Gomez, who sought to recover approximately $329,000 owed under an alleged employment agreement that allowed him to recover 150 percent of his taxable income for the preceding year. While employed, Gomez had received a $40,000 annual salary and commissions. The insurance company defended the bank under a reservation of rights. When the claim settled for $175,000, the insurance company refused to contribute more than $10,000, based on its assertion that the policy did not cover contractual obligations to make termination payments and in any event limited coverage to one year of Gomez s base salary. Affirming the trial court, the Tenth Circuit Court of Appeals directed the insurer to pay all of the bank s settlement costs as well as its attorney fees in the coverage action, pursuant to a Kansas statute that permits a court to award attorney fees if an insurer refuses to pay a claim without just cause or excuse. 5 Rejecting the insurer s position that coverage was not available because the amount paid to Gomez represented a termination payment rather than salary for services rendered, the Tenth Circuit held that the policy language calling for the insurer to indemnify the bank for up to a maximum of one year of claimant s salary established a limit on liability and did not restrict coverage to claims for salary. 6 In reaching this conclusion, the court noted that the policy also afforded coverage for claims brought by former employees and applicants, and explained that damages awarded to those claimants could never be compensation for services rendered, which was what the bank contended was meant by salary. 7 The court also rejected the insurer s contention that the policy at most covered the payment of Gomez s $40,000 base salary and not the additional amounts paid in the settlement for commission income. In so holding, the court agreed that the term salary was ambiguous and could reasonably be read to include commissions and other taxable forms of income. 8 The failure to define terms clearly in the basic insuring clause was also the source of the dispute in TVN Entertainment Corp. v. General Star Indemnity Co. 9 The EPL policy at issue in TVN covered losses sustained because of wrongful employment acts such as discrimination, defamation, harassment, and breach of implied employment contracts. However, the policy excluded coverage for (1) damages determined to be owing under written or express employment contracts and (2) losses in the form of commissions, bonuses, profit sharing or benefits pursuant to a contract of employment. 10 An employee terminated by TVN recovered an arbitration award entitling him to approximately $13,000,000 in damages proximately caused by [TVN s] breach of the Employment Agreement. 11 TVN argued that coverage was available for the arbitrator s award because (1) liability was imposed for breach of the implied covenant of good faith and fair dealing, as well as for breach of the contract; and (2) the award included damages for stock options granted to the employee in a paragraph of his employment agreement that was separate from the provisions addressing his annual salary. Affirming summary judgment for the insurer, the Ninth Circuit Court of Appeals held that the policy unambiguously excluded coverage for the arbitrator s award because it awarded damages proximately caused by breach of the employment agreement irrespective of whether TVN was also held liable on a noncontract theory. 12 The court held that the award of stock options was in any event encompassed by the policy s exclusion of bonuses, profit sharing, or benefits awarded pursuant to a contract of employment. The dissent took the position that the policy s exclusion for express agreements was limited to contract provisions targeted at payments made in event of termination, such as severance pay, golden parachutes, and the like, and did not include the employee s separate contractual entitlement to stock options. 13 While disagreeing that the policy excluded coverage for the contract claim, the dissent agreed that the damages awarded for the stock options were excluded but deemed them a form of benefits rather than profit sharing. Consequently, the dissent would have directed the insurer to indemnify TVN for the portion of the arbitrator s award that did not relate to stock options. 14 In a recent decision that underscores how important it is to carefully review the policy in its entirety, the Fifth Circuit Court of 3

4 Appeals in Coleman v. School Board of Richland Parish, 15 interpreted conflicting provisions in an educator s legal liability policy that affirmatively afforded coverage for discrimination, harassment, and breach of employment contracts in the definition of wrongful act but excluded coverage for wrongful acts committed with actual knowledge of their wrongful nature or with the intent to cause damage. The insured school board sued when the insurer refused to defend or indemnify it against an action brought by a former employee alleging race discrimination, breach of employment contract, and abuse of rights. Relying on decisions addressing other types of policies, the insured argued that its reasonable expectations of coverage would be defeated if the insurer was allowed to deny coverage when the policy affirmatively afforded coverage for discrimination and breach of contract, which are both inherently intent based, by relying on the inconsistent exclusion for intentional acts. The Fifth Circuit held that the exclusion was enforceable and unambiguous because it did not completely negate the coverage provided in the basic insuring clause. 16 It observed that claims for disparate impact would still be covered under the policy. The Fifth Circuit also relied on Louisiana public policy against affording insurance for intentional wrongdoing to support its decision to enforce the policy exclusion. After concluding that the intentional acts exclusion defeated coverage for the discrimination and breach of contract claims, the Fifth Circuit held that the insurer had nonetheless breached its duty to defend because the underlying action also asserted claims for the school board s vicarious liability and civil rights, which did not require a showing of intent or knowing wrongdoing. 17 The Fifth Circuit remanded for a determination as to whether any portion of the board s settlement of the underlying action could be apportioned to the covered claims and for a determination of the board s covered defense costs. In Andrews Transport, Inc. v. CNA Reinsurance Co., Ltd., 18 the insured sought a declaration that CNA owed it defense coverage against a class action brought by truck drivers alleging that Andrews wrongfully withheld state and federal taxes and unemployment insurance deductions from their checks. The EPL policy issued by CNA in 1998 afforded coverage for Loss amounts on... account of a Claim by a Claimant because of an Insured Event to which this Policy applies. The policy defined claimant as a current or former Employee with employee defined as individual[s] whose labor or service is engaged by and directed by an insured entity, including [i]ndependent contractors who claim to be an Employee. The initial and a first amended class action petition sought to certify a class of independent truck drivers. A second amended petition asserted that the class members were employees not independent contractors after all. 19 Faced with these inconsistent allegations, the trial court held that CNA did not owe Andrews Transport a defense as to the initial and first amended petition because the independent contractor claimants did not assert in those petitions that they qualified as employees. 20 Applying Texas s eight corner rule, which limits the defense determination to a comparison of the policy against the complaint, the court held that the second amended petition was brought by claimants within the scope of this policy because the independent contractors now contended that they qualified as employees. The trial court went on to conclude, however, that the claims asserted did not allege any wrongful employment decisions within the scope of the policy s basic insuring clause because the petition did not concern decisions to employ, terminate, evaluate, discipline, promote or demote, or concern a breach of an implied employment contract [or] breach of the covenant of good faith and fair dealing in the employment contract. 21 While the petition alleged that Andrews Transport violated a special relationship that the parties enjoyed because of their truck leasing agreements, the court held that this did not trigger application of the EPL policy because it did not concern an employment contract and Texas does not recognize a duty of good faith and fair dealing in the employment context. The court also rejected the insured s contention that the plaintiffs claims for the allegedly wrongful withholding of payroll taxes and unemployment insurance deductions fell within the policy s coverage for other employment decisions which violate public policy. 22 On appeal, the Fifth Circuit held in Andrews Transport v. CNA Reinsurance Company, Ltd. 23 that the initial, as well as the amended, petition stated a potentially covered claim because the plaintiffs alleged in the alternative, in the 4

5 first petition, that even if they were deemed employees rather than independent contractors, they still were not subject to the payroll withholdings claimed by the defendant. The inclusion of this alternative, albeit inconsistent, allegation meant that the plaintiffs in the underlying allegation could potentially satisfy the policy s claimant definition. The Fifth Circuit also held that the trial court erred in concluding that the underlying claims did not qualify as potentially covered wrongful employment decisions because the reference in that policy definition to other employment decisions which violate public policy was broad and vague enough to include the employer s allegedly wrongful decision to claim the payroll withholdings. It did not matter that Texas law did not recognize a separate cause of action for public policy violations because the policy only required that the underlying complaint allege employment decisions that violate public policy, irrespective of whether those allegations stated a viable legal theory for recovery. A dispute over the wrongful act provisions in an EPL policy was also resolved in favor of the insurer in Noxubee County School District v. United National Insurance Co. 24 In Noxubee, the insured school district was sued by over 100 current and former employees seeking overtime pay allegedly owed under the Fair Labor Standards Act (FLSA), with statutory penalties and attorney fees. Affirming summary judgment for the insurer, the court held that the school district s deliberate decision not to compensate its employees for overtime pay did not qualify as a wrongful act or wrongful employment act under the relevant EPL policy provisions. 25 The policy defined wrongful employment act as either the refusal to employ, the termination of employment, or coercion, demotion, evaluation, reassignment, discipline, defamation, harassment, humiliation, discrimination or other employmentrelated practices, policies, acts or omission. The court held that even if the FLSA claims were deemed to assert wrongful acts or wrongful employment acts, the policy s exclusion for back wages, overtime, or future wages would in any event preclude coverage for the plaintiffs claims. In so holding, the court rejected the insured s contention that the exclusion only applied to the actual award of overtime under the FLSA and did not defeat coverage for any award of penalties or attorney fees under the Act. 26 Upon concluding that coverage was not afforded for the plaintiffs claims, the court disposed of the insured s claim that the insurer acted in bad faith by denying its claim without conducting an adequate investigation into the potential availability of coverage. As the court noted, the insurer retained outside coverage counsel to evaluate its initial determination of no coverage after the school district had challenged its denial and then acted properly by timely advising the insured of its decision to stand by its initial denial of coverage. 27 While not presenting a dispute over the scope of the basic EPL insuring clause, the decision of Steinberg v. Syndicate 212 at Lloyd s of London 28 is interesting because the court had to decide whether claims against company directors concerning alleged wrongdoing concerning a shareholders agreement and the plaintiff s resignation were governed by the D&O or EPL portion of a multipart policy. Coverage under the EPL portion was subject to satisfaction of a $1,000,000 retention. The D&O coverage part was not subject to a retention. The insurer argued that because the plaintiff s claims implicated multiple coverage sections of the policy, the insureds had to satisfy the highest single retention, namely, the $1,000,000 retention under the EPL part. The court concluded that although the plaintiff s claims appeared to implicate both coverage parts, only the D&O portion provided actual coverage, with the result that the applicable retention in this case is zero. 29 In reaching this conclusion, the court pointed to an exclusion in the EPL part that precluded coverage for that portion of Loss which is covered under any other Coverage Section of this Policy. Because the D&O part provided coverage for any claims also covered under the EPL part, the exclusion was implicated, eliminating coverage under the EPL part. Late Notice Defenses and Reporting Requirements In contrast to the preceding decisions that concern the scope of particular EPL insuring clause provisions, the decisions regarding late notice and reporting requirements present issues that frequently arise under a wide range of policy types. It is nonetheless useful to see how these common problems arise in the EPL context. In JanJer Enterprises, Inc. v. Executive Risk Indemnity Inc., 30 the court, applying Maryland law, affirmed summary judgment for the insurer based on the insured s fail- 5

6 ure to provide its vice president of claims with written notice of its receipt of a sexual harassment suit as soon as practicable or no later than sixty days after the claim was first made. In rejecting the insured s argument that the insurer was required by Maryland law to show prejudice to deny coverage based on a late notice defense, the Fourth Circuit Court of Appeals emphasized that the policy expressly stated that compliance with the notification of claim provision was a strict condition precedent to coverage. 31 The determination that the EPL policy applied to claims first made and reported during the policy period meant that the dispute was not governed by Maryland Insurance Code section , which prevents insurers from denying coverage based on late notice under liability insurance policies unless the insurer can establish actual prejudice from the late notice. 32 The court held that the insured s identification of the pending EEOC claim on a policy renewal application did not satisfy the policy s reporting requirement because it was submitted to an agent at Executive Risk, not to the vice president of claims, as specified in the policy. The court noted that [s]uch a requirement is aimed at preventing an insured from insisting that an insurer s underwriting department sift through a renewal application and decide what should be forwarded to the claims department on the insured s behalf. 33 The insured law firm in St. Paul Reinsurance Co. v. Williams & Montgomery, Ltd. 34 also argued that its EPL insurers could not rely on a late notice defense to deny coverage unless it could demonstrate that it was prejudiced by the insured s noncompliance with the policy s reporting requirements. The court rejected this argument, holding that compliance with the reporting requirements in a claimsmade policy is a condition precedent to coverage. 35 The dispute in Williams & Montgomery stemmed from the law firm s discharge of four nonequity partners and one equity partner in March By letter dated April 1, 1999, the partners challenged their discharge and demanded certain moneys allegedly owed. On April 7, 1999, the Chicago Daily Law Bulletin published an article about the firings in which the partners were quoted as saying they were owed bonuses and compensation. Shortly thereafter, the law firm submitted its application for the renewal of its EPL policy for the period commencing on May 3, The firm did not notify its insurers of the partners demand before submitting the application and responded in the negative when asked in the renewal application if there had been any change in the status of any EPL claims or circumstances other than reported to the insurer following the submission of the application for the preceding year s policy. On April 29, 1999, the terminated partners sent another written demand letter that the firm admitted was received before the May 3 inception date of the renewal policy. In June 1999, the discharged partners filed two lawsuits. The firm did not report either of these suits until October 15, Not surprisingly, the insurers denied coverage based on the firm s breach of the policy s notice and claim reporting requirements. The insurers also asserted a claim for rescission based on the failure to disclose the change of circumstances in the renewal application. In granting the insurers summary judgment, the court held that the notice and reporting requirements in claims-made policies are conditions precedent to coverage for two basic reasons. First, the notice provision in a claims-made policy allows the insurer to conduct a prompt and thorough investigation. Second, and more importantly, strict adherence to expiration dates preserves an insurance carrier s ability to set rates without having to consider the possibilities of inflation beyond the policy period, upward-spiraling jury awards, or later changes in the definition and application of negligence. 36 Under Illinois law, as with many jurisdictions, a showing of prejudice is only required in instances involving an occurrence policy. 37 The law firm s argument that there was no claim against it until the partners filed their lawsuit, because the letters should be regarded as negotiations regarding the payment of certain bonuses for which judgment could not be granted, was rejected as unreasonable, unrealistic and unpersuasive. 38 In addition to declaring the three presuit letters claims under the policy, the court held that the article publicizing the dispute also qualified as a claim because it contained quotes from the partners regarding their demand for compensation. As the court observed, even after the lawsuits were filed, the firm waited more than two and a half months to notify its EPL insurers of the litigation. As discussed further below, the court held that the insurers 6

7 were also entitled to rely on rescission grounds to deny coverage based on the failure to disclose the change of circumstances in the renewal application. 39 Underscoring the importance of carefully examining the applicable policy language, an insured was able to obtain coverage for a $400,000 judgment entered in a sexual harassment lawsuit filed during its policy period despite its failure to notify its EPL insurer of the preceding EEOC claim received during a prior policy period in Lodgenet Entertainment Corp. v. American International Speciality Lines Insurance Co. 40 Two reasons accounted for this differing result. First, the policy lacked the customary provision that designates all claims arising out of the same or related employment practices a single claim received at the time of the initial claim. 41 The court also pointed to other policy language that supported its conclusion that the EEOC claim and the ensuing lawsuit could be treated as separate claims, such that the insured complied with the reporting requirements by providing notice of the lawsuit during the policy period. Second, the renewal application did not ask any questions regarding whether there was a change in the risk insured, or whether LodgeNet was aware of any facts which may lead to administrative or civil proceedings. 42 Consequently, the EPL insurer could not rely on rescission or misrepresentation grounds to deny coverage. In CIM Insurance Corp. v. MidPac Auto Center, Inc., 43 the insured s failure to comply with the reporting requirements in the first of two EPL policies issued by separate companies allowed the insurer under the first policy, Clarendon Insurance Company, to obtain summary judgment. As noted further below, the second EPL insurer was entitled to deny coverage because of a breach of written contract exclusion in its policy. An insured s failure to notify its insurer of an administrative agency claim also entitled its EPL insurer to obtain summary judgment for breach of the policy s claims reporting requirements in Specialty Foods Systems, Inc. v. Reliance Insurance Co. 44 Specific EPL Policy Exclusion Disputes To date, EPL coverage disputes have addressed the following types of exclusions that are prevalent in EPL and other types of policies. Coming years will no doubt generate decisions addressing other typical EPL exclusions and restrictions, including provisions that deny or restrict coverage for knowing violations of law (public policy exclusions), provisions that exclude or establish reduced sublimits for punitive damages, and provisions that exclude coverage for costs associated with providing accommodations or training, as well as claims that fall within workers compensation or other non-epl policies. Meanwhile, the following decisions shed light on important EPL exclusions. Breach of contract exclusions. The treatment of claims for breach of express and implied employment agreements is one of the primary areas in which EPL policies vary widely, leading to divergent results in coverage disputes. As noted above, in TVN Entertainment Corp. v. General Star Indemnity Co. 45 the EPL policy covered losses sustained because of wrongful employment acts, including the breach of implied employment contracts, but excluded coverage for damages owed under written or express employment contracts. The court held that the exclusion regarding written or express employment contracts unambiguously allowed the insurer to deny coverage for the arbitrator s award of approximately $13,000,000 in damages proximately caused by breach of the employment agreement notwithstanding the fact that the arbitrator amended his decision to also impose liability on TVN for breach of the implied covenant of good faith and fair dealing. This modification did not allow the insured to obtain coverage because the award was still for damages proximately caused by the breach of the written agreement. In contrast, in CIM Insurance Corp. v. Mid Pac Auto Center, Inc. 46 coverage was precluded for the plaintiff s wrongful termination claim because it arose out of a written employment agreement. The EPL policy provided coverage for certain wrongful employment practices, which was defined to include claims for breach of an implied agreement but expressly excluded coverage for damages arising out of the breach of an express written or oral contract of employment or an express obligation to pay monies, including bonuses, in the event of termination of employment. In Peoples Mortgage Corp. v. Kansas Bankers Surety Co., 47 an EPL policy that broadly defined employment claims to include claims for breach of a verbal or written employment contract 7

8 obliged the insurer to indemnify its insured for $175,000 paid to settle claims under a written employment agreement. As noted above, insurers that exclude claims or damages for breach of express or written agreements do so with the view that an insured should not be permitted to gain coverage for contractual obligations assumed in the course of routine business operations. Companies need to consider whether they want to negotiate and pay for the added protection that follows from including claims for breach of written and implied employment agreements in the definition of covered employment claims. Fines and penalties. EPL policies, like most other policy forms, typically contain exclusions for fines and penalties. Courts readily enforce these exclusions on the view that it would defeat public policy to allow a wrongdoer to obtain insurance against statutorily imposed fines or penalties. In Big 5 Corp. v. Gulf Underwriters Insurance Co., 48 the court held that an EPL insurer was entitled to rely on the policy s exclusion for criminal or civil fines or penalties imposed by law in denying coverage for approximately $2,750,000 paid by an employer to settle claims brought under the state wage code seeking, inter alia, penalties for the wrongful withholding of wages. Perhaps signifying the widespread recognition of the enforceability of this type of exclusion, the insured did not dispute that statutory penalties are not recoverable under the Policy but instead focused its efforts on seeking coverage for the portion of the settlement attributable to the payment of withheld wages, as noted below. 49 Amounts owed for unpaid wages and FLSA violations. The Big 5 decision is interesting not only because the trial court enforced EPL provisions that stated that (1) loss does not include claims made under the FLSA or similar federal, state, or local laws, and (2) employment claims do not include the payment of wages to former employees, but also because it held that amounts paid for wrongly withheld wages constitute restitutionary relief and/or the disgorgement of wrongfully withheld benefits that does not qualify as an insurable loss or damages in any event. Specifically, after holding that amounts paid to settle the employees claims for withheld wages were excluded under the policy s definition of employment claims and loss, the trial court held that a claim for restitution of wages is not covered by the policy in any event because [d]amages within the meaning of an insurance contract do not include the restoration of an ill-gotten gain. 50 In so holding, the court relied on Bank of the West v. Superior Court, 51 and Cortez v. Purolater Air Filtration Products Co. 52 In Cortez, the California Supreme Court held that the payment of unlawfully withheld wages is restitutionary relief that does not qualify as the payment of damages within the meaning of a policy. Because Big 5 could not demonstrate that the settlement payment included any compensatory damages beyond the return of withheld wages, it was not entitled to coverage. As noted above, the Ninth Circuit did not address this issue on appeal, when affirming summary judgment for the insurer on the ground that the policy unambiguously excluded coverage for the unpaid wages sought by the plaintiffs. Underscoring an important distinction between EPL provisions that provide defense cost reimbursement for covered claims and the broader duty-to-defend provisions contained in general liability (and some types of EPL policies), the trial court held that Big 5 was not entitled to recover the legal fees it incurred in defending against the employees claims because the relevant EPL provisions only required the insurer to reimburse Big 5 for defense costs incurred as an ingredient of a covered loss. 53 In Noxubee County School District v. United National Insurance Co., 54 the insurer also prevailed on its argument that an employer s deliberate decision not to compensate its employees for overtime pay did not qualify as a wrongful act or wrongful employment act under the relevant EPL policy provisions. The court held that even if the plaintiffs FLSA claims were deemed to assert wrongful acts or wrongful employment acts, the policy s unambiguous exclusion for claims seeking back wages, overtime or future wages (even if designated as liquidated damages) or arising from collective bargaining agreements defeated coverage in any event. 55 In so holding, the court rejected the insured s contention that the exclusion only applied to the actual award of overtime under the FLSA and did not encompass the award of penalties or attorney fees under the FLSA. Prior acts or retroactive date. EPL policies, like most types of errors and omissions or wrongful act policies, frequently restrict coverage to claims asserted during the 8

9 policy period that concern conduct postdating a designated retroactive date in the policy. Insurers often insist on this type of provision when taking over for another insurer or when writing coverage that incepts after a period in which the insured had no equivalent coverage. These provisions can give rise to disputes over whether a claim arises out of or concerns conduct that commenced before or after the relevant retroactive date. In Schultze, DDS v. Continental Insurance Co., 56 an EPL insurer was required to defend its insured against defamation, sexual harassment, and wrongful discharge claims because the defamation claim involved conduct after the policy s prior acts inception date and the duty to defend that claim obliged the insurer to defend the entire lawsuit. This holding again underscores the difference between EPL policies written on a duty-todefend as opposed to a duty-toreimburse basis because the latter form may only have required the insurer to pay the legal fees attributable to the covered claim. Rescission Claims Given the heightened awareness of potential grounds for rescinding or denying coverage based on misrepresentations in the application process, courts have also been asked to determine whether grounds exist to rescind EPL policies. Hartford Insurance Co. of Illinois v. BKM Enterprises, Inc. 57 demonstrates the significant rescission remedies an EPL insurer can obtain when an insured fails to disclose pending claims or circumstances that could reasonably be construed to give rise to potential claims in the application for insurance. BKM held an EPL policy with Pacific Insurance Company for the period from August 2, 1999, to August 2, In January 2000, BKM received an EEOC notice of a disability discrimination charge filed by Hipsky. In May 2000, BKM received a racial discrimination and retaliation claim filed by another employee, Giugliano, with the EEOC and California Fair Employment Department. BKM did not report either claim to Pacific Insurance. In June 2000, BKM completed an application seeking renewal EPL coverage through Hartford. 58 BKM did not disclose either claim despite broad questions in the application seeking information regarding any pending claim and/or awareness of any fact or circumstance or any actual or alleged act, error or omission which might give rise to a claim that would fall within the scope of the proposed coverage. 59 Relying on the application, Hartford issued a renewal EPL policy for the period from August 2, 2000, through August 2, Before learning of the nondisclosures, Hartford paid approximately $221,000 in defense costs on the Giugliano claim and approximately $19,000 on the Hipsky claim, as well as $266,501 in the defense of other claims brought against BKM during the renewal policy period. After learning of the nondisclosures, Hartford filed a declaratory judgment action seeking to rescind the policy retroactive to its inception date, to withdraw from participating in the defense of any claim for which coverage was sought, and to recover all amounts paid under the policy, less premiums, plus prejudgment interest at the rate of 10 percent per year. The Orange County Superior Court granted Hartford the relief sought on summary judgment. The California Court of Appeal affirmed. In rejecting BKM s contention that Hartford waited too long to seek rescission, the court held that this is not a simple case of the late tender of a claim where an insured failed to promptly notify an insurer of a claim made during the policy period. 60 An Illinois court granted an EPL insurer summary judgment on its rescission claims in St. Paul Reinsurance Co. v Williams & Montgomery, Ltd. 61 in addition to holding the insurer entitled to deny coverage on late notice grounds. As noted above regarding the late notice and reporting requirements, the law firm failed to notify its EPL insurer that it had received demand letters concerning its discharge of four nonequity and one equity partner before May 1999, when its EPL policy expired and its renewal policy commenced. After holding that the breach of the reporting requirements defeated coverage under both policies, the court held that the firm s failure to disclose its receipt of the demand letters and its awareness of changes in circumstances that could give rise to claims constituted a material misrepresentation that permitted the insurer to rescind the latter policy. 62 The court explained that Illinois law permits rescission when an insured s misrepresentation is made with the actual intent to deceive or materially affects either the acceptance of the risk or the hazard assumed by the company. 63 As with many other jurisdictions, Illinois courts treat the failure to disclose material information in response to 9

10 a question in an insurance application [as] a material misrepresentation as a matter of law. 64 In holding that the law firm violated its good faith duty requirement to disclose all relevant facts which may affect its policy terms, the court observed that an applicant cannot pick and choose what to tell his insurer, or take it upon itself to determine whether the information it holds regarding a change in circumstances or conditions that may lead to a future claim are material.... It is the insurer s responsibility to sift through an applicant s responses and make that determination on its own. 65 Given the materiality of the misrepresentation, the court did not need to determine whether the nondisclosure was intentional or evaluate the insured s reasons for omitting the requested information. When policies are renewed without requiring that the insured submit a renewal application or without seeking detailed information on renewal, courts view rescission claims with much more skepticism. The decision of Lodgenet Entertainment Corp. v. American International Specialty Lines Insurance Co. 66 is instructive in this regard. As noted above, the court rejected the insurer s argument that coverage for a civil action was defeated by the insured s failure to provide notice of its receipt of a preceding EEOC charge because the EPL policy did not contain language treating the civil action and EEOC charge as a single claim deemed to occur during the prior policy period. The insurer s argument that it was entitled to deny coverage because the insured failed to disclose the EEOC charge in its application for the relevant renewal policy also failed because the renewal application did not ask any questions regarding whether there was a change in the risk insured, or whether LodgeNet was aware of any facts which may lead to administrative or civil proceedings. 67 In evaluating the bases for a potential rescission claim, it is important to also consider information the insurer may have by reason of information given to its agents or provided through other sources. In St. Paul Reinsurance Co., Ltd. v. Commercial Financial Corp., 68 London Market insurers sought to rescind an EPL policy issued to Commercial Financial Corporation (CFC) because of its alleged failure to disclose its October 1999 termination of three employees of a recently acquired bank, Security State Bank (SSB). IBIS, a soliciting agent for the London Market insurers, aided CFC in completing its application for an EPL renewal policy. When the application was being completed, CFC was not seeking EPL coverage for SSB from the London Market because it intended to obtain a separate policy for SSB and CFC through Executive Risk Indemnity Insurance. CFC told IBIS of the discharge of the SSB employees when completing the application for its policy, but the IBIS representative concluded that those discharges did not need to be listed on the application because the EPL policy would not include SSB. Subsequently, CFC decided to instead add SSB to the London Market policy issued by U.S. Risk. IBIS provided U.S. Risk with information regarding the number of SSB s employees and confirmed that it abided by CFC s employment procedures but did not specifically reference the discharges and that information was not requested in any further application. In denying U.S. Risk s claim for rescission, the court observed that the crux of the litigation turned on the question of whether IBIS served as an agent for CFC or for U.S. Risk. Concluding that IBIS served as a soliciting agent for U.S. Risk, the court held that IBIS s knowledge of the SSB discharges precluded rescission because U.S. Risk was charged with IBIS s knowledge and therefore could not prove that it justifiably relied on CFC s alleged failure to disclose the SSB discharges when it added SSB to its EPL policy. 69 Reformation and/or Negligent Misrepresentation In an interesting contrast to the rescission claims, the court in Asbury Automotive Group LLC v. Chrysler Insurance Co. 70 denied an insurer s motion to dismiss the insured s claim that it fraudulently and negligently misrepresented that an excess umbrella policy provided EPL coverages equivalent to those provided in the underlying primary policy. The insurer moved to dismiss on the ground that the fraud and negligent misrepresentation claims were inconsistent with the policyholder s claim requesting that reformation of the policy at issue. In denying the motion, the court held that the plaintiff could proceed with alternative theories of recovery, at least at that early stage in the proceedings. In Asbury, the plaintiff car dealership owner negotiated and purchased primary and excess umbrella policies from Chrysler Insurance in February 1999 for the period from February 1999 through February The plaintiff did not receive the actual policies until July The plaintiff alleged that the insurer s representative 10

11 advised him that the umbrella policy would include all of the types of coverage included in the primary policy, including EPL coverages. In 1999 and 2000, a number of current and former employees filed EPL claims with the EEOC and the Oregon Fair Employment Practices Bureau. Chrysler defended the claims under the primary EPL policy. In August 2000, Chrysler authorized the payment of $1,500,000 for settlement but advised the plaintiff that the primary policy limits were almost exhausted. The plaintiff claimed that this was when it first learned that the umbrella policy did not include EPL coverages. In allowing the claims to proceed, the court held that the plaintiff s fraud and negligent misrepresentation claims were adequately supported by allegations that the insurer misled it regarding the scope of coverages in the umbrella policy to obtain the $1.8 million premium (a tempting motivation indeed), covering liabilities of an operation extended over multiple locations in at least eight states. 71 The plaintiff s fraud allegations were also supported by the improbability that a sophisticated business organization would negotiate and accept an umbrella insurance policy that failed to cover the same areas of liability as the primary insurance policy as well as the allegations regarding the lengthy delay in the defendant s delivery of the relevant insurance policies. 72 Bad Faith Claims Policyholders seeking coverage under EPL policies often include common-law or statutory bad faith or extracontractual claims with their claims seeking coverage. In jurisdictions that permit bad faith claims against the insurer, the policyholder may seek to recover consequential damages going beyond the available policy proceeds, perhaps for a settlement or judgment that would not otherwise be covered under the policy. In jurisdictions in which a prevailing policyholder does not automatically recover declaratory judgment attorney fees, a plaintiff may seek to recover attorney fees incurred because of the allegedly bad faith denial of coverage. In Peoples Mortgage Corp. v. Kansas Bankers Surety Co., 73 discussed above, the Tenth Circuit held that the trial court did not abuse its discretion in awarding the prevailing policyholder attorney fees upon concluding that the insurer engaged in bad faith when it unreasonably refused to investigate the [availability of coverage for the] Gomez claim and unreasonably refused to participate in the mediation at which the parties discussed the basis for the claim. 74 Apart from this decision, research has not revealed any other reported decisions in which an EPL insurer has been held liable for extracontractual bad faith damages beyond the award of attorney fees incurred in seeking coverage. Even in those jurisdictions that recognize bad faith claims against insurers, these claims almost invariably fail if the insurer establishes either that no coverage exists or that it relied on fairly debatable or plausible grounds in denying coverage. In each of the following decisions, previously addressed in this article, bad faith claims against insurers were dismissed. In Noxubee County School District v. United National Insurance Co., 75 the court affirmed summary judgment for the insurer on the plaintiff s bad faith claim because it properly denied coverage for the FLSA overtime claims and there was no evidence that it failed to properly investigate the potential availability of coverage. In Big 5 Corp. v. Gulf Underwriters Insurance Co., 76 the court held, after concluding that coverage was not available for the wage and related claims asserted against Big 5, that Gulf has convincingly argued [that] it engaged in no bad faith actions. The court is inclined to agree with Defendant Gulf; there can be no bad faith where there is no coverage. 77 In Lodgenet Entertainment Corp. v. American International Speciality Lines Insurance Co., 78 the court granted the insurer summary judgment on the policyholder s bad faith claim because, even though its coverage denial was mistaken, the plaintiff could not demonstrate that the insurer lacked a reasonable basis for denying coverage or acted in reckless disregard of whether there was a reasonable basis for coverage. Conclusion The first wave of judicial decisions construing EPL policies included several disputes over the intended scope of the primary insuring clause that went before federal circuit courts of appeal. In most of these decisions, the courts were confronted with policy language that was unclear and/or inconsistent in important respects, either because the parties attempted to tailor policy provisions too narrowly to address specific types of claims or because of unsuccessful efforts to reconcile the typical exclusion for intended acts found in other types of general liability 11

12 policies against the goal of providing coverage for intent-based employment claims. It is perhaps not surprising that initial disputes over EPL policies stemmed at least in part from limitations and inconsistencies in the policies basic insuring agreement because there was considerable uncertainty when EPL first came onto the market over how much insurance protection could be provided for intentbased employment claims. As insurers and policyholders tested the application of EPL policies against the spectrum of employment claims and gained comfort in the underwriting and purchase of this type of coverage, broad-based EPL coverage was offered by an increasing number of insurers. While EPL policies continue to differ in significant respects, depending on the applicable exclusions and available endorsements to coverage, the basic insuring clause in most policies is now broad enough to encompass the typical range of statutory and common-law employment practices claims, including wrongful discharge, retaliation, and unlawful discrimination based on race, gender, age, disability, religion, and other protected categories. Consequently, it stands to reason that forthcoming decisions concerning EPL policies will focus less on the basic insuring clause than specific policy exclusions and endorsements that vary more widely depending on the range of protection purchased by the policyholder. Because EPL policies are typically written on a claims-made basis, in which coverage is afforded for claims received and reported during the policy period, we will no doubt continue to see decisions addressing whether the policyholder s noncompliance with the policy s reporting requirements justified an insurer s denial of coverage based on late notice. While most courts treat notice requirements under claims-made policies as a condition precedent to coverage that does not require any showing of prejudice by the insurer, it is likely that this proposition will continue to be tested, particularly in jurisdictions that have not already resolved this question with regard to other types of claims-made policies. As with any other type of policy, evidence that the insured knew of but failed to disclose existing claims or knowledge of circumstances that could reasonably be expected to give rise to claims can prompt an insurer to seek to rescind the policy (or deny coverage for omissions or misrepresentations in the policy application). When the underlying dispute is not significant, insurers may opt against pursuing rescission remedies. In situations where the underlying exposure is significant, such as class actions or multiparty claims, rescission claims will more likely be pursued. Consequently, we can expect to see additional decisions addressing rescission claims under EPL policies in coming years. An issue that has not been squarely addressed in the first wave of decisions addressing EPL policies is the treatment of multiple claims that arise out of the same, or related set of, facts. Many policies contain exclusions for prior and pending litigation, or for claims that arise out of conduct that predates a specified retroactive date in the policy. When addressing other types of policies, courts sometimes have to decide whether an insurer is entitled to deny or limit coverage because a newly filed complaint concerns or arises out of matters addressed in judicial or administrative proceedings that commenced before the policy inception, or that concern conduct that predates the policy s retroactive date. If the policyholder did not provide an earlier insurer with notice of the prior related claim, it may find itself without coverage for the newly filed related claim. There is no reason why similar disputes should not arise under EPL policies. Given the range of issues presented by EPL policies, counsel for insurers, policyholders, agents, and brokers will be able to turn to a growing body of reported decisions that deal specifically with EPL policies, without having to rely as heavily on the ability to extrapolate relevant holdings and principles from decisions involving other types of liability policies. Notes 1. EEOC Charge Statistics Fact Sheet, at 2. EEOC Litigation Statistics Fact Sheet, at html F. App x 232 (10th Cir. 2003). 4. Id. at 234. Most EPL policies are written on a claims-made basis, in which coverage is afforded for qualified claims that are first made, and often first reported, during the policy period. This contrasts with occurrence-based policies that respond to injury, damage, and/or offenses committed during the policy period. 5. Id. at Id. at Id. 8. Id. at F. App x 211 (9th Cir. 2003). 10. Id. 12

13 11. Id. 12. Id. at Id. 14. Id. at F.3d 511 (5th Cir. 2005). 16. Id. at Id. at F. Supp. 2d 516 (N.D. Tex. 2001). 19. Id. at Id. at Id. at Id. at F. App x 87 (5th Cir. 2002) So. 2d 1159 (Miss. Sup. Ct. 2004). 25. Id. at Id. at Id WL (Pa. Com. Pl. 2003). 29. Id. at * F. App x 410, 411 (4th Cir. 2004). 31. Id. at Id. at Id. at 413 n.1 (citing Am. Cas. Co. of Reading, Pa. v. Continisio, 17 F.3d 62, 69 (3d Cir. 1994)) WL (N.D. Ill. 2001). 35. Id. at * Id. (quoting City of Harrisburg v. Int l Surplus Lines Ins. Co., 597 F. Supp. 954 (M.D. Pa. 1984)). 37. Id. at *4 (citations omitted). 38. Id. 39. Id. at * F. Supp. 2d 987 (S.D. 2003). 41. Id. at Id. at F. Supp. 2d 1092 (Haw. 2000) F. Supp. 2d 541 (E.D. La.), aff d without opinion, 200 F.3d 816 (5th Cir. 1999) F. App x 211 (9th Cir. 2003) F. Supp. 2d 1092 (Haw. 2000) F. App x 232 (10th Cir. 2003) WL , *4 (C.D. Cal. 2003). This summary judgment decision was issued as a tentative ruling, which the trial court adopted in its entirety in Big 5 Corp. v. Gulf Underwriters Ins. Co., WL (C.D. Cal. 2003). On appeal, the Ninth Circuit affirmed summary judgment for the insurer but did so on the ground that the policy clearly and unambiguously excluded coverage for the unpaid wages sought in the underlying action without addressing the policy s exclusion for fines or penalties imposed by law or the trial court s determination, discussed below, that the underlying action sought restitutionary relief and disgorgement of withheld wages that the policy did not cover in any event. Big 5 Corp. v. Gulf Underwriters Ins. Co., 136 Fed. Appx. 996 (9th Cir. 2005) WL , *4 (C.D. Cal. 2003). 50. Id P.2d 545 (Cal. 1992) P.2d 706 (Cal. 2000) WL at *5 (citing Helfand v. Nat l Union Fire Ins. Co., 10 Cal. App. 4th 869 (1992)) So. 2d 1159, 1164 (Miss. Sup. Ct. 2004). 55. Id N.W.2d 510 (N.D. 2000) WL (Cal. App. 4 Dist. 2004). 58. A short while after submitting the policy application, BKM received a claim from a third person. The court concluded that it did not need to address whether BKM s failure to disclose the claim received between submission of the application and policy inception provided independent grounds for rescission because summary judgment was properly granted to the insurer based on the insured s failure to disclose the two claims received prior to submission of the policy application WL at * Id. at * WL (N.D. Ill. 2001). 62. Id. at * Id. at *5 (citing to ILL. INS. CODE 215, ILL. COMP. STAT. 5/154 (2001)). 64. Id at * Id. (citations omitted) F. Supp. 2d 987 (S.D. 2003). 67. Id. at F. Supp. 2d 1057 (N.D. Iowa 2001). 69. Id. at WL (E.D. Pa. 2002). 71. Id. at * Id F. App x 232 (10th Cir. 2003). 74. Id. at * Miss. LEXIS 1202 (Miss. Sup. Ct. 2004) WL (C.D. Cal. 2003), aff d on other grounds, 136 Fed. Appx. 996 (9th Cir. 2005). 77. Id. at * F. Supp. 2d 987 (S.D. 2003). 13