Indemnity agreements and additional insured
agreements go hand in hand. The insurer agrees to produce the defense and
indemnify its insured in the indemnity agreement. Sometimes, the insurer is
kept in the dark about a case for years only to learn about a suit shortly
before trial or after a settlement is reached.
In Kmart Corp. v. Footstar, Inc.,
777 F.3d 923 (7th Cir. 2015), the Seventh Circuit Court of Appeals was called
on to resolve such a situation where, under an agreement between Footstar and
Kmart, Footstar operated the footwear departments in various Kmart stores as
though they were islands. Footstar employees could only work in those
departments if they had written permission from Kmart. On July 27, 2005, a
Footstar employee tried to help a customer get an infant carrier off a shelf
outside the footwear department, and the customer was injured. She sued, and
Kmart eventually sought indemnification for the settlement and defense costs
from Footstar and its insurer, Liberty Mutual Insurance.
Facts
Section 18.1 of the Master Agreement required Footstar to defend and
indemnify Kmart under certain conditions. On July 27, 2005, a customer named
Judy Patrick walked into a Kmart store in Hollywood, Florida. According to her
complaint, she asked for assistance from Alex Sehat, who turned out to be a
Footstar employee, in getting a stroller down from a shelf. Sehat, along with a
Kmart employee, reached up and attempted to bring the stroller down. As they
were bringing it down, an infant carrier inside the stroller fell and struck
Patrick in the face. The accident took place in the infant/stroller department,
which is entirely outside of the Footstar department.
Patrick sued Kmart alleging negligence, with no mention of Footstar in her
initial complaint. But, during the course of the litigation, Patrick's
counsel discovered that Sehat was actually a Footstar employee and called
Footstar a year into the suit to get Sehat's employment records. Footstar
contacted Liberty Mutual.
Shortly thereafter, Kmart defense counsel wrote to Footstar formally
requesting defense and indemnification for the first time. Footstar forwarded
the request to Liberty Mutual, and Patrick amended her complaint 2 days later
to include Footstar as a defendant. Liberty Mutual wrote Kmart refusing to
defend or indemnify, stating, "Footstar is not responsible for the
referenced claim as it is not a product liability incident."
Kmart settled with Patrick 8 months later for $300,000 and $10,000 in Kmart
gift cards.
The Declaratory Relief Action
Kmart then filed a complaint in this action originally against Footstar only
but then added Liberty Mutual, alleging both owed Kmart a duty of defense and
indemnification for the Patrick suit. The magistrate judge entered partial
summary judgment on Kmart's breach of contract and declaratory judgment
counts, finding that both defendants owed a duty to defend, but only as of
January 24, 2008, when Kmart first requested defense. The court found that
Liberty Mutual and Footstar also had a duty to indemnify but only for
Footstar's relative fault, which a jury apportioned at 15 percent.
The court also found that Liberty Mutual did not act in bad faith by denying
coverage, and Kmart did not breach the notice provisions of the policy and
Master Agreement. Kmart appealed, naming only Liberty Mutual as an appellee,
while Liberty Mutual and Footstar cross-appealed.
The issues on appeal were whether:
- Footstar and/or Liberty Mutual had a duty to indemnify Kmart;
- Liberty Mutual and/or Footstar had a duty to defend Kmart and, if so,
when that duty began;
- Liberty Mutual acted in bad faith by denying coverage;
- Kmart breached the notice provisions of the policy and Master Agreement;
and
- the court erred in denying Kmart's motion for pre-judgment
interest.
Duty To Indemnify
Liberty Mutual and Footstar appealed the magistrate judge's
determination that they had a duty to indemnify Kmart for the Patrick suit. The
magistrate judge found Liberty Mutual and Footstar liable because it determined
the injury arose from Footstar's work. However, Liberty Mutual/Footstar
contended that the court ignored the requirement that any injury had to arise
"pursuant to" or "under" the Master Agreement to trigger
indemnification, and the Master Agreement explicitly prohibited Sehat's
out-of-department action that resulted in the injury.
The duty to indemnify only arises where the insured's activity and the
resulting damages actually fall within the coverage of the policy. To determine
whether the activity actually fell within the coverage of the policy, the court
reviewed the plain language of the policy. Indemnity contracts are to be
strictly construed, and any ambiguity in the agreement is to be construed most
strongly against the indemnitee—in this case, Kmart.
Under subpart 1 of the additional insured clause, Liberty Mutual was liable
to Kmart for injuries "arising out of" Footstar's
"work." Under subpart 2, the policy applied only to "coverage
and limits of insurance required by" the Master Agreement, but coverage
would "in no event exceed[ ] either the scope of coverage or the limits of
insurance provided by this policy."
Turning to Footstar, the court held it had a duty to indemnify for those
injuries "arising out of [Footstar's] performance or failure to
perform under this Agreement." Again, any indemnification obligation only
relates to those acts taken "under [the] Agreement." A breach of
contract, however, was not a "performance" under the Master
Agreement—it was an act taken in direct violation of the contract. For the same
reasons as with Liberty Mutual, the court held that Footstar had no
indemnification obligation for its performance.
Duty To Defend and Pay Defense Costs
The duty to defend is broader than the duty to indemnify. The complaint
alleged that Footstar caused Patrick's injuries by "negligently and
carelessly … failing to properly remove" the infant stroller from the
shelf. Based on these allegations and the expansive way "arising out
of" has been interpreted by Illinois and New Jersey courts, the claim
could have been potentially covered under subpart 1. There was certainly an
argument that Patrick's injury arose from Sehat's "work or
operation[ ]," especially if the injury does not have to be "pursuant
to" the Master Agreement, as required by subpart 2.
Although the court rejected these readings for indemnity purposes, two
triers of fact found that the injury arose from Footstar's work, including
the jury and the magistrate judge, showing that the injury was potentially
coverable under the terms of the Master Agreement and policy.
Bad Faith
While Liberty Mutual had a duty to defend, the flipside was that Liberty
Mutual had a defensible position and therefore did not act in bad faith in
denying coverage. "[I]n order to prove a claim of bad faith under New
Jersey law, a plaintiff must prove that: '(1) the insurer lacked a
'fairly debatable' reason for its failure to pay a claim, and (2) that
the insurer knew or recklessly disregarded the lack of a reasonable basis for
denying the claim.'" Certain Underwriters
at Lloyd's of London v. Alesi, 843 F. Supp. 2d 517 (D.N.J.
2011) (citation omitted).
Though Liberty Mutual's denial letter erroneously refused coverage based
on the nature of the complaint—there was an indemnification requirement for
personal injury and not just products liability—Liberty Mutual's position
was, at the very least, "fairly debatable" at the time Liberty Mutual
denied coverage.
Late Notice
Kmart did not alert Liberty Mutual or Footstar to the suit until 30 months
after it first learned about the claim and 1½ years after the suit was filed.
This was in contravention of the notice provisions in both the Master Agreement
and the policy. However, that did not mean that Kmart's actions precluded
it from recovering defense costs. Under New Jersey law, an insurer must show
that it was appreciably prejudiced by its insured's failure to cooperate in
order to disclaim coverage based on that failure. Absent any evidence that the
case would have come out differently had the insurer been involved earlier, the
court found no bad faith on Liberty Mutual's part.
Conclusion
Almost every policy of liability insurance and indemnity agreement requires
prompt, if not immediate, notice to the insurer and the indemnitor. In this
case, that prompt notice was not provided. Regardless, defense duty was owed
because there was a potential for coverage, but only from the time of notice.
Also, even though the insurer denied coverage in error, it had a fairly
debatable position and thus avoided bad faith allegations.
© 2015 Barry Zalma, Esq., CFE