As in many other coverage respects, the

Employment Law Alert October 2000 The Aftermath of Schmidt v. Smith: Successfully Pursuing Employment Claims Under Workers Compensation Insurance Policies By Lynda A. Bennett, Esq. As in many other coverage respects, the landscape of New Jersey law regarding insurance coverage for employment-related claims is unique. Policyholders in most states must look to their Comprehensive General Liability ( CGL ) policy for any hope of coverage for employment claims and must obtain a favorable ruling on the Employee Exclusion that is now standard in most CGL policies. New Jersey policyholders, on the other hand, are most likely to find coverage for employment claims under the Employer s Liability section of their Workers Compensation policies. In a pair of decisions issued on the same day, the New Jersey Supreme Court found that: (1) CGL policies that contain an Employee Exclusion provide no coverage for employment claims; and (2) the Employer s Liability section of a Workers Compensation policy must provide coverage for bodily injuries that arise from employment claims. See American Motorists Ins. Co. v. L-C-A Sales Co., 155 N.J. 29 (1998)( LCA ) and Schmidt v. Smith, 155 N.J. 44 (1998)( Schmidt ). Not surprisingly, the Court s unique approach to resolving the question of coverage for employment claims has left the New Jersey insurance community bewildered. CGL carriers are relieved because their absolute Employee Exclusion is being enforced. Workers Compensation carriers are scrambling to develop claims handling procedures to respond to claims that they apparently never intended to cover. Finally, policyholders are attempting to figure out exactly how much coverage is afforded by the Schmidt decision. This article briefly discusses the rationale behind the LCA and Schmidt decisions, then focuses on the principle coverage issues that have arisen in the wake of Schmidt. G LCA: The Employee Exclusion Is Enforceable In A CGL Policy. The plaintiff in LCA brought suit against his former employer and various officers of the company for bodily injuries that he allegedly suffered as a result of being terminated because of his age in violation of New Jersey s Law Against Discrimination ( LAD ). The Plaintiff advanced various theories of liability including breach of contract, negligence, and tortious interference with contract. LCA sought a defense and indemnity coverage for these claims under its CGL policies. The insurance companies denied coverage on the basis of the Employee Exclusion. The Employee Exclusion precludes coverage for bodily injury claims brought by employees arising out of and in the course of employment by the insured. The Court s analysis of the exclusion focused on the interpretation of the phrase arising out of - specifically whether it was intended to mean causally connected (i.e., but for) or proximately caused by (i.e., substantial nexus). LCA, 155 N.J. at 35. After reviewing decisions from other jurisdictions, the Court held that the Employee Exclusion at issue clearly and unambiguously precluded coverage for the former employee s wrongful termination claim because his claim was causally connected to his employment with the company. Id. at 41. In so holding, the Court found that the exclusion applied even if the specific acts of harassment or discrimination occurred outside the workplace. Id. at 42. For example, the Court found no merit to the former employee s assertion that the exclusion should not apply because certain alleged harassing telephone calls were made to his home and therefore took place This document is published by Lowenstein Sandler PC to keep clients and friends informed about current issues. It is intended to provide general information only. L 65 Livingston Avenue Roseland, New Jersey Telephone 973.597.2500 www.lowenstein.com 07068-1791 Fax 973.597.2400

outside the scope of his employment. The Court held that the alleged calls nevertheless arose out of the employment relationship. Id. The Court also summarily rejected the former employee s argument that the exclusion did not apply because he was a former employee. Id. at 42. Accordingly, the Court upheld the insurance companies denial of the former employee s claim on the basis of the Employee Exclusion. Id. at 43. Thus, LCA clearly establishes that New Jersey policyholders may not obtain coverage for employment claims under a CGL policy if it contains an Employee Exclusion. All is not lost for policyholders, however, because the Court s decision in Schmidt also clearly establishes that workers compensation policies must provide coverage for bodily injuries that result from employment claims. Schmidt: Coverage For Employment Claims Is Available Under Workers Compensation Policies. The employee in Schmidt brought a classic sexual discrimination suit against her employer, PAV, and its president, Smith. Initially, Schmidt s complaint was limited to claims against only Smith, alleging intentional conduct (i.e., hostile work environment in violation of the LAD, assault, battery, invasion of privacy, and intentional infliction of emotion distress). It was not until two years later that Schmidt brought PAV into the suit when she alleged that PAV and Smith were liable under negligence theories (i.e., negligent infliction of emotional distress and failure to train/supervise). PAV and Smith sought both defense and indemnification from the insurance company that had issued both CGL and workers compensation policies to PAV. The insurance company disclaimed coverage under both policies. While PAV and Smith brought a third party insurance coverage action against the insurance company, the trial court decided to proceed with the merits of Schmidt s case first. The insurance company did not heed the trial court s urging to participate in the defense of Schmidt s claim. Ultimately, the jury awarded Schmidt $80,000 in compensatory damages. The jury found Smith liable for violations of the LAD and certain intentional torts while PAV was found liable only for violation of the LAD. The jury did not allocate the damages between the causes of action or between Smith and PAV. Thus, the jury gave no indication whether PAV s liability arose directly from its own violation of the LAD or vicariously from Smith s violation of the LAD. Likewise, the jury s verdict was ambiguous on the issue of PAV s vicarious liability for the intentional torts committed by Smith. However, based on the fact that the negligence claims were unsuccessful, one thing was clear: the only remaining basis of liability was intentional wrongdoing so that coverage did not exist under the CGL policy. Accordingly, the only insurance coverage avenue available to PAV and Smith was the Employers Liability section of PAV s workers compensation policy. The total cost (i.e., defense and indemnity) incurred by PAV and Smith was $181,730. The Supreme Court found that coverage for certain employment discrimination claims existed under the Employers Liability section of a Workers Compensation policy so that employers were in compliance with their obligations under New Jersey Workers Compensation laws. Schmidt, 155 N.J. at 49-50. Under those laws, employers are required to carry workers compensation insurance coverage sufficient to pay for bodily injuries suffered by employees as a result of intentional wrongs committed by the employer or fellow employees. Id. at 49. The Court found that PAV had a reasonable expectation of coverage under its workers compensation policy because the purpose of the employers liability section of the [insurance company s] policy was to bridge the gap between the typical workers compensation obligations and the obligations arising from injuries not covered by the workers compensation regime. Id. at 50-51. Pursuant to the terms of the Employers Liability section of the policy, the insurance company was obligated to cover bodily injuries caused by accident or disease that arose out of and in the course of the injured employee s employment. Id. at 49. Notwithstanding this obligation, the insurance

company cited two exclusions to justify its denial of the claim under the workers compensation policy: (1) an exclusion barring coverage for bodily injury intentionally caused by or aggravated by the policyholder (Exclusion C5 ); and (2) an exclusion precluding coverage for damages arising out of coercion, demotion, evaluation, reassignment, discipline, defamation, humiliation or discrimination against or termination of any employee, or any personnel practice, acts or omissions ( Exclusion C7 ). Id. at 50. The Court summarily found that Exclusion C5 did not apply because there was not sufficient evidence that PAV intended to harass Schmidt. Id. at 51. The Court similarly rejected the insurance company s attempt to avoid its obligation to provide coverage by relying on Exclusion C7. Id. The Court found that strict enforcement of Exclusion C7 would violate the public policy principles underlying New Jersey s workers compensation scheme to ensure coverage for all types of physical bodily injuries suffered by employees. Id. at 52. The Court also noted that emotional distress injuries qualify as bodily injuries for coverage purposes when the emotional injuries as accompanied by physical manifestations. Id. (quoting Voorhees v. Preferred Mut. Ins. Co., 128 N.J. 165, 179 (1992)). In determining whether the exclusion may be applied, the Court held that the nature of the employee s allegations and resulting damages must be carefully analyzed. Schmidt, 155 N.J. at 52. Where -- as in Schmidt s case -- an employee asserts that the alleged discrimination is intentionally inflicted by a fellow employee and results in physical emotional distress injuries (i.e., crying fits, nausea, hair loss, body aches, medically treated depression, etc.), the Court found that Exclusion C7 is not enforceable. Id. Conversely, if an employee claims that the alleged discrimination arises out of a class of discomforts that one typically would not associate with bodily injury - criticism, demotion, evaluation, and defamation, the Court found that the exclusion is still valid. Id. The Court specifically noted that employers may obtain coverage for these types damages and other non-bodily injury related damages by purchasing an EPL product because it is specifically designed to protect against a host of workplace related claims. Id. at 53. Almost as an aside, the Court noted that the record was devoid of any evidence that PAV s liability stemmed from non-bodily injury damages. Id. at fn. 1. Because the jury did not allocate its damage award among the two parties, much less the many causes of action asserted by Schmidt, the Court could find only that it was highly unlikely that any portion of [Schmidt s] award was unrelated to her bodily injuries. Id. Significantly, the Court also held that the insurance company could not be heard to complain about the jury s failure to apportion the damages because it refused to participate in the defense when it had the chance. Id. Based on these findings, the Supreme Court held that PAV was entitled to a complete defense from the insurance company and full indemnity for the judgment award. Id. at 53. The Court s ruling on defense costs was interesting, if not somewhat surprising. Even though PAV did not become involved in the suit until two years into the litigation and it was the only named insured under the policy, the Court found that the insurance company was obligated to pay all of the defense costs incurred from the beginning of the litigation. Id. Providing sparse reasoning, the Court noted that Schmidt s complaint alleged a risk that was covered by PAV s workers compensation policy and, therefore, the defense obligation was triggered. Id. The Court also found that the insurance company was liable for all of the defenses costs incurred because the defense strategy for the employer and employee was identical. Id. The Court noted that its holding in S.L. Industries, Inc. v. American Motorists Ins. Co., et al, 128 N.J. 188 (1992) favoring apportionment of defense costs between covered and non-covered claims, did not impact the insurance company s defense obligation. Schmidt, 155 N.J. at 53. Because the defense strategy was identical for both PAV and Smith and they were represented by the same attorney, the Court found that it would be virtually impossible to apportion the defense

costs with any certainty as required by S.L. Industries. Therefore, the insurance company was fully responsible. Id. Pursuing Employment Claims in the Wake of Schmidt In the aftermath of Schmidt, policyholders and insurance companies have begun to grapple with the many questions left open by the Court s decision. The battle lines primarily have been drawn over two issues: (1) the scope and nature of the defense obligation created by Schmidt; and (2) the proper method of allocating defense and indemnity costs between covered and non-covered claims. Since there have been no reported decisions addressing the scope of available coverage since Schmidt, policyholders and insurance companies have had to find ways to settle around these issues. Subject to the distinct facts of each employment claim, the golden rule is often compromise. The Scope and Nature of The Defense Obligation As noted above, Schmidt was a ground-breaking decision for a variety of reasons, including the fact that the employer was awarded a complete defense for itself and the accused employee. The employer obtained this award even though: (1) it was not named in the case until two years after the case was originally filed; and (2) the policy at issue expressly provided that only the corporate entity was a named insured under the policy. The basis for the Court s decision seemed reasonable since the employer and the employee asserted the same, unified defense: the plaintiff s allegations were totally false. In such circumstances, costs incurred specifically to defend the accused employee are de minimus and, as the Court found in Schmidt, generally not capable of being quantified or apportioned. 155 N.J. at 53. Notwithstanding the Court s ruling, carriers continue to resist providing a defense to the accused employee where the named insured is only the corporate entity. In Miller v. McClure, the only other published decision addressing coverage for employment claims under workers compensation policies, the Appellate Division resolved the issue in favor of the insurance company. Miller, 326 N.J. Super. 558. There, an accused employee sought coverage under his employer s workers compensation policy in connection with a sexual harassment claim brought by a fellow employee. Citing the definition of the named insured, the Appellate Division held that the accused employee was not entitled to coverage since the definition language included only the corporate entity. Id. at 568. Curiously after its ruling in Schmidt, the Supreme Court affirmed the Appellate Division s Miller decision in a per curiam opinion even though it appears to be at odds with Schmidt. 162 N.J. at 575. Nonetheless, in light of Miller, policyholders generally must fight an uphill battle to recover defense costs that are incurred on behalf of accused employees. Another key issue that arises is whether the policyholder has the right to choose its own defense counsel after tendering a claim to the carrier. Since Schmidt, the carriers response to this dilemma has been mixed. In some instances, the insurance company has assigned its own chosen counsel to defend the entire claim. Notably, however, this offer often comes with strings i.e., the insurance company reserves the right to pursue reimbursement for any costs incurred to defend ultimately non-covered claims. Even though most CGL policies do not contain any policy language allowing an insurer to seek reimbursement of defense costs, New Jersey courts have recognized that insurance companies have such a right. See e.g., Hartford Accident & Indemnity Co. v. Aetna Life & Cas. Ins. Co., 98 N.J. 18, 24 (1984); Morrone v. Harleysville Mut. Ins., 283 N.J. Super. 411, 421 (App. Div. 1995). Other carriers have attempted to assign counsel to defend only those portions of the claim that relate to the potentially covered bodily injury damages while leaving the policyholder to fend for itself to defend the remainder of the claim. There is no New Jersey case endorsing this approach to comply with the duty to defend. However, as a practical matter, this type of defense may unduly prejudice the policyholder in the underlying action. For

example, separate defense counsel seeking discovery and trial testimony regarding bodily injury may make a plaintiff appear more sympathetic and/or induce a jury to return a larger verdict in favor of the plaintiff. This may be particularly problematic where punitive damages are at issue since insurance companies repeatedly disclaim any defense or indemnity obligation. Creating a sympathetic plaintiff may result in a punitive damage award against the company where such a claim may not otherwise have resulted. Conversely, separate insurance company appointed counsel appointed may make no effort to develop a record addressing the alleged bodily injury claims. Without a well-developed factual record in the underlying action, the policyholder is obviously at a disadvantage when it comes time to allocate between covered and non-covered claims. Still other carriers have agreed to allow the policyholder to select its own counsel but the insurance company will only pay that firm pursuant to the insurance company s approved litigation guidelines, including provisions regarding hourly billing rates, disbursements and expenses. Again, no New Jersey court has expressly addressed the propriety of this type of defense. In any event, none of these scenarios are particularly palatable to policyholders. Large corporate policyholders do not want small or inexperienced law firms defending their multi-million dollar employment suits. Rather, these companies usually want their national counsel or specialized employment defense counsel defending them and their good name in court. Likewise, policyholders do not want to lose the benefit of the litigation insurance for which they have paid significant premium dollars. Finally, they do not want stringent guidelines imposed on their defense counsel that may jeopardize the quality of the defense provided. To further complicate matters, as noted above, there is very little precedent in New Jersey-- in the context of employment claims or otherwise -- addressing the rights of policyholders and the obligations of insurance company with respect to defense issues. The reason for this absence of authority is mainly attributable to New Jersey s bizarre approach to the duty to defend. Unlike all other states, New Jersey does not always follow the time honored maxim that the duty to defend is broader than the duty to indemnify. See e.g., Washington Occupational Health Assoc. V. Twin City Fire Ins. Co., 670 F. Supp. 12 (D.D.C. 1987); International Paper Co. v. Continental Co., 35 N.Y.2d 322, 361 N.Y.S.2d 873 (1974). While New Jersey courts have recognized this general concept, see e.g., Danek v. Hommer, 28 N.J. Super. 68 (App. Div. 1953) aff d o.b., 15 N.J. 573 (1954); Mount Hope Inn v. Travelers Indemn. Co., 157 N.J. Super. 431 (Law Div. 1978) and most recently in Schmidt, 155 N.J. at 53, the problem arises in the application of the doctrine. In the now infamous decision Burd v. Sussex Mut. Ins. Co., 56 N.J. 383 (1970), the New Jersey Supreme Court held that an insurance company may not be required to provide a contemporaneous defense for a claim if the facts that determine the existence of coverage will not be resolved in the underlying lawsuit. In such a situation, the insurance company need only reimburse the policyholder for defense costs if, in a subsequent action, the events at issue in the underlying case are found to be covered by the policy. But see, Sands v. CIGNA, 289 N.J. Super. 344, 355 (App. Div. 1995) (holding that an insurance company may not transform duty to defend into a duty to reimburse by creating an illusory conflict). While Burd has not expressly been invoked by worker compensation carriers in the context of employment claims, the issue arises because employment claims nearly always involve a mix of potentially covered and non-covered claims e.g., sexual harassment resulting in emotional distress (covered) and retaliatory discharge resulting in economic damages (not covered). The historic non-existence of the duty to defend in New Jersey has left policyholders and insurance companies to their own devices in trying to resolve these issues. Most policyholders believe that they should be able to select their own defense counsel and have the insurance companies pay the bills in full. In certain jurisdictions, policyholders have such a right especially where -- as is

the case in most employment claims brought pursuant to Schmidt -- the insurance company has not accepted full indemnity responsibility for the claim. See e.g., San Diego Navy Federal Credit Union v. Cumis Insurance Soc y, 208 Cal.Rptr. 494, 506 (Ct. App. 1984); Maryland Casualty Co. v. Peppers, 355 N.E.2d 24, 30-31 (Ill. 1976); Public Serv. Mut. Ins. Co. v. Goldfarb, 425 N.E.2d 810, 815 (N.Y. 1981). New Jersey does not have a clear position on this issue one way or the other. There are two older cases that agree with the general principle that a policyholder is entitled to select its own counsel and the insurance company pay the bills. See, Dunne v. Fireman s Fund America Ins. Co., 69 N.J. 244 (1976) and Danek, supra. In Dunne, the Supreme Court found that, where a potential conflict exists, the insurance company is contractually bound to pay the costs and fees of a policyholder s chosen defense counsel: Under the terms of the policy, Fireman s Fund is under a duty to defend the suit against its insured since the allegations in the complaint include some subject matter, negligence, which clearly falls within the coverage. We envision possible conflict in this defense because coverage may not exist if liability is fixed on some other predicate, such as a violation of the right of privacy. Therefore, in the first instance, the insured should select their own counsel, subject to the carrier s approval. In the event such approval is not forthcoming, the selection should be made by the assignment judge. Reasonable fees and costs of the defense are to be paid by Fireman s Fund. 69 N.J. at 252 (emphasis added). Likewise, in Danek, the Appellate Division acknowledged, even in the face of a potential coverage conflict, the policyholder was entitled to an independent and contemporaneous defense paid for by the insurance company: It is not reasonable to say that the duty of the insurer to defend is determined after the issue of liability has been litigated and decided. The stipulation for defense of actions, even if groundless, would be of little value if that obligation did not arise when a claim is stated in the pleadings, which, if sustained, would be within the protection afforded by the policy. 28 N.J. Super. at 80 (citations omitted). Nonetheless, New Jersey courts addressing the duty to defend since Dunne and Danek have refused to embrace a mandate that a meaningful and contemporaneous defense must be provided for underlying lawsuits giving rise to insurance claims. See e.g., Hartford, 98 N.J. at 24; S.L. Industries, 128 N.J. at 214. But see. Morrone, 283 N.J. Super. at 421 (stating in dicta that an insurance company may be obligated to finance the cost of defense subject to a right of reimbursement). The reality is that often times the insurance company does not have a strong preference with respect to which firm defends the policyholder in the underlying action. Rather, the insurance company is focused only on the amount that it will have to pay to defend the case. As noted above, one compromise to overcome this impasse may be the insurance company s agreement to use the policyholder s chosen counsel but at a cut rate and subject to the insurance company s stringent rate and disbursement schedules. Notably, courts have begun to take notice of -- and sharply criticize -- these guidelines. See e.g., Dynamic Concepts, Inc. v. Truck Ins. Exchanges, 61 Cal.App.4th 999, 1009 (Ct.App. 1998)(questioning the wisdom and propriety of so-called outside counsel guidelines and noting that insurer-imposed restrictions on discovery or other litigation decisions may violate the duty to defend obligation); Delmonte v. State Farm Fire & Cas. Co., 90 Hawaii 39, 975 P.2d 1159, 1169 (Haw. 1999)(noting that an insurance company may be subject to bad faith if it fails to authorize actions necessary to conduct a zealous defense); In the Matter of Rules of Professional Conduct and Insurer-Imposed Billing Rules and Procedures,

2000 MT 110 (Montana Supreme Court, April 28, 2000)(finding that insurance company imposed billing and practice rules violated the Montana Rules of Professional Conduct because the rules interfered with an attorney s ability to exercise professional judgment and provided undivided loyalty to their client, the policyholder); and WNS, Inc. v. American Motorists Insurance Co., 270th Texas Judicial District Court (June 5, 2000), reported in Coverage Magazine, Vol. 10, Number 1 (January/February 2000) at 33 (reporting a jury s verdict that Kemper s Litigation Guidelines violated the Texas Insurance Code by engaging in unfair settlement practices, violated the Texas Deceptive Trade Practices Act, and breached the Commercial General Liability policy by refusing to pay [the policyholder s] costs of defense incurred in defending a claim covered by the policy. ]). No New Jersey court has addressed these guidelines in any reported decision; however, the New Jersey Supreme Court has recognized that [a]lthough an insurer may select the attorney to represent an insured, that attorney owes his first allegiance to this client in the action, the insured, and bears the responsibility t o represent him properly in all respects. Prevratil v. Mohr, 145 N.J. 180, 194 (1996). No doubt, the defense issues presented by Schmidt are going to require additional judicial intervention. However, until further guidance is received from New Jersey courts, the parties will have to continue finding ways to compromise and settle around these issues. Panoply of Allocation Issues Notwithstanding the murky preliminary defense issues that can arise, it has become clear that the most significant issue that has emerged in the wake of Schmidt is allocation. As noted above, the Schmidt decision established that coverage is available for employment claims that allege bodily injuries, including emotional distress injuries that become physically manifested. The difficulty is that most times a former employee does not limit his or her employment suit to alleged bodily injuries. Instead, the employee will claim bodily injury as well as breach of contract damages, lost wages, attorneys fees, punitive damages, and other equitable relief. Indeed, sometimes the complaint does not even expressly include allegations of bodily injury but the employee later complains of such injuries in interrogatory responses or during deposition testimony. Under these circumstances, Schmidt does not provide a clear direction with respect to the scope of the insurance company s defense or indemnity obligation. Obviously, the policyholder wants the workers compensation carrier to provide a complete defense and pay as much of the judgment and/or settlement as possible. As a practical matter, however, the carrier is inclined to limit its defense and indemnity obligation by finding ways to allocate between covered and noncovered claims under a S.L. Industries theory. Flemington Furs: Guidance Concerning How To Allocate The Appellate Division recently provided some guidance on these issues in the unreported decision New Jersey Manufacturers Co. v. Flemington Fur Co., No. A-2659-98T1 (App. Div., August 1, 2000). In Flemington Furs, the employer was named, along with certain individual employees, in a lawsuit brought by a former employee that alleged a host of employmentrelated claims under the New Jersey LAD and CEPA statutes. The plaintiff sought both compensatory and punitive damages for her alleged injuries and specifically claimed that she had suffered humiliation, loss of self-esteem, embarrassment, disruption of her personal and professional life, mental pain and anguish and emotional distress that made her both physically and emotionally ill. The case went to trial and resulted in a substantial verdict in favor of the plaintiff. Specifically, the plaintiff prevailed on her compensatory damage claims and successfully invoked the attorney fee-shifting provision of the LAD. Pursuant to Schmidt, the employer placed its workers compensation carrier on notice of the claim and sought payment of defense costs and coverage for the resulting jury award. As has become the trend since Schmidt, the insurance company s coverage counsel attended the

trial and obtained the court s permission to submit special jury interrogatories to secure an allocation of any damage award. Thus, the jury s $87,250 compensatory damage award was broken down as follows: $22,250 due to lost earnings arising from constructive discharge; $65,000 in other damages ; and $7,500 for damages sustained from plaintiff s stomach problems and headaches. Id. at 4. Additionally, the plaintiff was awarded an eyeopening $489,091.85 in attorney fees and counsel fee application costs. Following trial of the underlying action, the insurance company resisted its defense and indemnity obligations on a number of grounds which have become prominent in nearly all post-schmidt employment coverage claims. First, the carrier claimed that Flemington Furs was not entitled to a defense or indemnity because it engaged in intentional conduct that was excluded pursuant to Exclusion C5. Recall that in Schmidt, the Court noted that Exclusion C5, addressing intentional acts, may still be invoked by carriers if there is a sufficient showing that the employer is an active participant in the alleged sexual harassment or other alleged wrongful conduct. In Schmidt, the Court concluded that the factual record was insufficient to make such a showing. Unlike the employer in Schmidt, Flemington Furs was not in a position to claim total ignorance of the plaintiff s allegations. Indeed, the trial court presiding over the coverage issues expressly found that Flemington Furs was aware of the harassing conduct alleged by plaintiff. However, the court also found that Flemington Furs awareness did not rise to the level of an intentional tort since it did take action to end the offensive conduct, although not sufficiently strong to stop it. Id. at 9. Because Flemington Furs conduct was merely negligent and not intentional, both the trial court and Appellate Division concluded that the insurance carrier could not avail itself of the C5 exclusion. Id. Next, the carrier argued that it should not have to indemnify Flemington Furs for any bodily injury award made in the underlying action unless there was sufficient evidence of a causal connection between the bodily injuries claimed and the alleged wrongful conduct. In other words, the insurance company was not denying that Schmidt created an indemnity obligation for certain bodily injuries. Instead, it claimed that other stressors in the plaintiff s life may have been the real cause for her injuries as opposed to her allegations of sexual harassment. Both the trial court and the Appellate Division summarily rejected the insurance company s argument. Notwithstanding that the plaintiff offered no medical testimony to establish causation in the underlying action, the Appellate Division seized on Flemington Furs own medical expert s concession that at least some of the injuries were related to her allegations. Id. at 10. The court also noted that the requirements governing bodily injury in the insurance context are less stringent than in other contexts: the Supreme Court has stressed that the physical manifestation necessary to trigger insurance coverage need not show the severe emotional distress that is needed to support a tort for infliction of emotional distress. Id. Moreover, although the Appellate Division did not address this particular issue in Flemington Furs, it has previously held that an insurance company may not use the policyholder s defense in the underlying action as a means to deny coverage for a claim. See Diamond Shamrock Chemicals v. Aetna Cas. & Sur. Co., 258 N.J. Super. 167, 245 (App. Div. 1992), cert. denied 134 N.J. 481 (1993)(holding that policyholders should not be placed in the hopeless untenable position of being forced to refute liability in the underlying action until the moment of settlement, and then of turning about face to prove liability in the insurance action. ). Nonetheless, based on the jury s response to the special interrogatories, the Appellate Division found that Flemington Furs was entitled to indemnity for the specific damages related to plaintiff s headaches and stomach pains as well as the other damages awarded for humiliation, anxiety, and emotional harm. The remainder of the Flemington Furs decision focused on allocation of the defense costs. Apparently,

the insurance company had fronted the policyholder a portion of the defense costs but eventually refused to fully defend. The insurance company argued that, at most, it should have been required to pay only 75% of the defense costs since only 75% of the compensatory damage claim was covered. The policyholder countered, and the trial court agreed, that a complete defense was mandated since the counts of the underlying complaint were so intertwined in the factual allegations covering all claims that no reasonable apportionment could be made pursuant to SL Industries. Id. at 12. The Appellate Division addressed the defense cost apportionment issue both with respect to Flemington Furs defense of the case as well as the plaintiffs attorneys fees that were awarded pursuant to the LAD fee-shifting provision. First, in examining plaintiff s attorney s fees, the court held that the proper analysis should focus on whether the plaintiff succeeded on any significant claim affording it some of the relief sought. Since such a showing had been made in the underlying action, the court held that the analysis should then shift to whether her attorneys services were based on a common core of facts or related legal theories for all claims or whether the award could be reduced in relation to time spent on unsuccessful or non-covered legal theories pursued. Notably, the court also confirmed, contrary to the insurance company s position, that there need not be a proportionality between counsel fees awarded and damages secured. Id. at 16. The Appellate Division also reinforced the rule set forth in S.L. Industries that, wherever possible, apportionment should be made between covered and non-covered defense costs. Id. at 16-17. In Flemington Furs case, the court acknowledged that the allegations of the underlying complaint overlapped significantly. However, unlike in Schmidt, the court found that the Flemington Furs plaintiff s claims went well beyond those that can be attributed to bodily injury. Id. at 18. Notwithstanding that each and every count realleged conduct related to sexual harassment, the court held that the gravamen of the complaint included gender discrimination in compensation and economic losses, as well as Flemington Furs negligent supervision and retention of [the accused employees]. Id. Since the trial court did not apportion any of plaintiffs attorneys fees or Flemington Furs defense costs, the Appellate Division remanded the case so for further disposition on allocation based on the plaintiff s successful claims. Id. at 19. Although not a published decision, Flemington Furs provides significant guidance regarding how to resolve some of the sticky allocation issues that arise in connection with the Schmidt-type employment coverage claims. Appreciate however, that Flemington Furs does not resolve all of the issues that may arise. For example, Flemington Furs apparently had the same workers compensation carrier during the entire period of the alleged harassment; therefore, the Appellate Division did not have to tread into the murky area of carving up responsibility for the claim among multiple insurers or differing lines of coverage. It is not uncommon in an employment suit for a former employee to claim that he or she was subjected to a hostile work environment during the entire course of the employment relationship and that several different people were involved in the alleged wrongful conduct. Assuming that the relationship spans over several years, the employer may have had different workers compensation carriers and/or it may have purchased other types of insurance that respond to employment claims, such as an Employment Practices Liability Policy. The employer also may be able to obtain coverage under a Directors & Officers Liability policy to the extent that it is required to indemnify directors or officers for alleged wrongful acts. The question becomes how does the policyholder recover all of the insurance proceeds to which it is entitled. Since neither Schmidt, Flemington Furs or any other New Jersey case resolves this issue, the policyholder is left to negotiate with each carrier on an individual basis and hope to achieve a complete recovery at the end of the day. Flemington Furs was also a deceptively easy case to resolve in terms of the carrier s indemnity obligation because the underlying case went to trial and special jury interrogatories were used. This is unusual. A more

likely resolution for most employment claims involves settlement with the plaintiff in the underlying litigation and subsequent negotiations with the insurance company. Since most settlement agreement do not allocate settlement proceeds among the claimed bodily injuries, economic losses, counsel fees, etc. alleged in the litigation, the only answer is to evaluate the particular facts of the plaintiffs claims and reach a compromise with the carrier. Conclusion True to its trailblazer reputation, the New Jersey Supreme Court has established a non-traditional method for obtaining coverage for employment claims under Workers Compensation policies. Even in the face of Flemington Furs, policyholders and insurance companies remain challenged to find ways to settle around the open issues that remain post-schmidt. Regardless, employers should not underestimate the valuable resource created by Schmidt that facilitates transferring at least some of the risk associated with these extremely volatile and expensive employment claims.