The Auto Dealer’s Coverage Form (ADCF) Policy: No Acts, Errors or Omissions Coverage for Violations of Auto Damage Disclosure Statutes.


In 2013, Insurance Services Office (ISO) rolled out its new Auto Dealers Coverage Form (ADCF) Policy. The ADCF Policy replaces the Garage Liability (GL) Policy which had been available for decades. One of the most major differences between the GL Policy and the new ADCF Policy is the addition of “Acts, Errors or Omissions” coverage in Section III of the ADCF Policy. This optional liability coverage is primarily designed to protect the auto dealer against claims resulting from the dealer’s violation of certain specifically described consumer protection laws.

Prior to the ADCF, most auto dealer insurers provided a similar type of “statutory errors and omissions” coverage which provided protection against suits for, among other things, violations of an “auto damage disclosure statute”.  However, the “Acts, Errors or Omissions” coverage of the ADCF Policy omits coverage for this potential liability.  Auto dealer insurers who wish to offer this coverage in connection with the ADCF Policy would need to write their own manuscript endorsements to insure the risk.

Historically, policies have not specifically defined what constitutes an “auto damage disclosure statute”.  However, in the automobile dealership industry it will include a statute which affirmatively requires a dealership to disclose vehicle damage to the buyer (typically in writing) prior to the sale of the vehicle to the buyer. The purpose of an auto damage disclosure statute is to ensure that vehicle condition information is provided to consumers so the consumer can make an informed purchasing decision.

Many states require disclosure of vehicle damage if the damage exceeds a certain percentage of the vehicle’s value. Generally, the damage percentage is quite low in the case of new vehicles and considerably higher in the case of used cars. See e.g., Minn. Stat. § 325F.664 subd. 2(a) (seller required to disclose damage exceeding four percent of the retail price of a new vehicle) and Minn. Stat. § 325F.6641 subd. 1(a) (seller required to disclose damage exceeding 70 percent of vehicle’s actual cash value immediately prior to sustaining damage). Georgia Code Ann. § 40-1-5(b) provides another example, by requiring that “prior to the sale of a new motor vehicle, a dealer must disclose to the buyer any damage which has occurred to the vehicle of which the dealer has actual knowledge and which costs more than 5 percent of the manufacturer’s suggested retail price to repair.” Other states have enacted statutes which require disclosure of prior damage, but do not specify any percentage above which prior damage must be disclosed to the purchaser. In Colorado, for example, the statutes and regulations require disclosure when the prior damage was “material.” Because “material” is a vague term, the Colorado Auto Dealers Association advises dealerships to disclose all prior damage of which the dealership has knowledge.

It is possible for prior auto damage disclosure claims to trigger coverage under the basic insuring provisions of the ADCF Policy if the claim alleges “bodily injury” or “property damage” resulting from the failure to disclose.  The ADCF Policy, like the former GL Policy, contains insuring provisions obligating the insurer to “pay all sums an ‘insured’ legally must pay as damages because of ‘bodily injury’ or ‘property damage’ to which this insurance applies caused by an ‘accident’, and resulting from your ‘auto dealer operations’ other than the ownership, maintenance or use of ‘autos’”. The ADCF Policy, in turn, defines the term “property damage” to require “damage to or loss of use of tangible property.”

Prior auto damage claims are generally not covered under such policy provisions because the claim does not satisfy the “bodily injury” or “property damage” requirements. In addition, the ADCF Policy requires an “accident” and usually contains several potentially applicable exclusions which may bar coverage, in whole or in part, for the claim. The damages caused by a dealership’s failure to disclose prior damage or misrepresentation regarding the condition of the vehicle usually only give rise to damages which are “economic” in nature — i.e., the buyer pays more than the vehicle was worth – as opposed to constituting covered “property damage.”

There have been a few notable cases addressing these issues:

In U.S. Fid. & Guar. Co. v. Dealers Leasing, Inc., 137 F. Supp. 2d 1257, 1260-63 (D. Kan. 2001), the court addressed these issues in the context of a commercial general liability policy which provided coverage for “bodily injury” or “property damage” caused by an “occurrence.” An occurrence was defined as “an accident including continuous or repeated exposure to substantially the same general harmful conditions.” The plaintiff in the underlying litigation alleged that Dealers Leasing was negligent by failing to discover safety defects in the minivan plaintiff purchased, failing to disclose the history of the minivan and failing to conduct a safety inspection. The plaintiff also alleged that Dealers Leasing’s conduct “constituted negligent misrepresentation” because it failed “to exercise reasonable care or competence in obtaining or communicating the information, including but not limited to misrepresentations about the identity and mileage of the minivan.” The court agreed with USF&G’s position that the policy did not afford coverage. First, the court held that the dealership’s alleged negligence and negligent misrepresentation did not cause the damages at issue – the complaint asserted that the minivan was in poor condition because it was involved in an accident and was negligently reconstructed. Second, the court held that any damage caused by the dealership’s alleged negligence or misrepresentations was not to “property damage” or “personal injury” as required by the policy. Rather, the damages were economic – the dealerships allegedly wrongful conduct caused the plaintiff to pay more for the minivan than it was worth and were not covered by the Dealer Leasing policy.

However, in AutoMax Hyundai South LLC v. Zurich American Ins. Co., 720 F.3rd 798 (10th Cir. 2013), the court held that the dealership’s failure to detect prior damage in a vehicle could constitute an “accident” (and thus an “occurrence”) at least where the where the dealership believed the vehicle was in perfect condition and the dealership neither expected nor intended to cause injury to its customers when it sold the vehicle. In addition, the customers in AutoMax Hyundai alleged that the sale resulted in emotional distress, a covered “injury” under the Zurich policy. Thus, the facts of the case suggested the possibility that the customers had suffered an injury resulting from a covered accident and Zurich was obligated to defend.

Note that in Dealers Leasing, Inc., 137 F. Supp. 2d 1257 (D. Kan. 2001), the plaintiff also alleged loss of use and emotional distress. These allegations were insufficient to establish coverage: “[w]hile the plaintiff would not have suffered the alleged loss of use and emotional injuries had she not purchased the minivan, these damages were caused by the condition of the minivan.” Further, the dealership’s counsel acknowledged that the “mental pain, anguish, emotional distress, embarrassment, humiliation, and inconvenience” were caused by the poor condition of the minivan, not by plaintiff’s purchase of the vehicle. Likewise, the alleged loss of use of the minivan was caused by its poor condition and need for constant repair.

This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney. Gregory J. Johnson ©All rights reserved. 2014.

Sonic Dealerships Lose Class Action Insurance Coverage Dispute with Chrysler Insurance: Court Finds Statutory Errors or Omissions Coverage did not apply to Dealers’ Failure to Disclose Price of Etch in Retail Installment Sales Contracts.


I recently posted an article providing a general overview of the insuring clause to the “Acts, Errors or Omissions” of the new Auto Dealers Coverage Form (“ADCF”) Policy.  (See the article here).  This optional coverage is primarily designed to protect the auto dealer against claims resulting from the dealer’s violation of certain specified consumer protection laws that regulate the dealer’s finance and insurance operations such as the federal Truth in Lending Act (“TILA”) and federal Consumer Leasing Act (“CLA”) and similar state laws.

While there have not been any reported decisions interpreting the acts, errors or omissions coverage of the ADCF policy, case law interpreting pre-ADCF statutory errors and omissions coverage will provide guidance when addressing the new policy. One of the more interesting recent cases to address the insuring clause requirements in a pre-ADCF policy is Sonic Auto., Inc. v. Chrysler Ins. Co., 2014 WL 1382070 (S.D. Ohio Apr. 8, 2014), a decision of the federal district court for the Southern District of Ohio.

Sonic, which owns automobile dealerships in various locations across the country, was named as a defendant in two similar lawsuits.  Like other dealers, Sonic arranges financing for the vehicles it sells and leases. Customers are provided with retail installment sales contracts or leasing agreements that are supposed to disclose the information required to be disclosed by the federal Truth in Lending Act (TILA) and Consumer Leasing Act (CLA), as applicable. One lawsuit was filed in Florida and alleged a cause of action under the Florida Deceptive and Unfair Trade Practices Act (FDUPTA). The named plaintiff sought to represent Sonic customers whose retail installment sales contracts failed to disclose the charge of an anti-theft insurance product sold by Sonic, called Etch. As part of its FDUPTA claim, the named plaintiff alleged that Sonic’s practices were unfair or deceptive because they violated the federal TILA and the Florida Retail Installment Sales Act (FRISA). The named plaintiff also alleged that Sonic sold Etch products knowing the product to be “largely valueless, ineffective against vehicle theft and unconscionably overpriced.”

The district court certified a class of Florida consumers and Sonic subsequently settled the lawsuit.

Another action was filed in North Carolina, but subject to arbitration. The claimants alleged that Sonic marketed and sold the Etch product as a mandatory add-on. They alleged that Sonic “in a uniform class-wide practice provided consumers with forms with blank prices thus allowing them to ‘pack’ and ‘stuff’ in the [Etch] product at exorbitant prices” and that “[t]he price charged to [claimants] for Etch was not disclosed in any of the transaction documentation provided to the consumer.” The arbitration demand included claims for (1) violation of the South Carolina Regulation of Manufacturers, Distributors, and Dealers Act (S.C. Dealers Act), (2) rescission to void Etch contracts and unlicensed insurance products; (3) breach of contract; (4) unjust enrichment; and (5) violation of the North Carolina Unfair and Deceptive Trade Practices Act (NCUDTPA). The arbitration demand did not include a separate claim for violation of the federal TILA or any state truth-in-lending statute. However, the claimants specifically argued at a summary judgment hearing that Sonic violated TILA and that the TILA violation could serve as the predicate unfair or deceptive act constituting a violation of the NCUDTPA. A settlement was approved by the North Carolina trial court which included all customers who purchased or leased a vehicle from a Sonic dealership which included the Etch product as part of the transaction but excluding customers from Sonic dealerships in Florida.

Thus, in both lawsuits the consumers alleged that Sonic’s practices involving the Etch product violated truth-in-lending statutes, but did not assert claims for damages under those statutes. Rather, the claimed truth-in-lending violations were asserted to serve as a predicate unfair or deceptive act for purposes of the causes of action under the UPTA and NCUDTPA.

Sonic claimed that Chrysler Insurance, which had issued three insurance policies to Sonic, breached its obligation to defend and indemnify Sonic. The Chrysler policies included endorsements which provided coverage for certain violations of truth-in-lending statutes. The endorsements obligated Chrysler to pay:

all sums an “insured” legally must pay as “damages” arising from an “occurrence” because of an alleged or actual negligent act or “error or omission” by an “insured” occurring during the policy period of this policy and resulting from … a civil violation of any federal, state or local statute that regulates specific disclosures required to complete . . . [c]onsumer financing agreements . . . [or] . . . [c]onsumer leasing agreements.

Chrysler asserted the suits were not covered because the damages sought in each action were pursuant to deceptive trade practices statutes not under truth-in-lending statutes and, additionally, the damages did not arise from negligent acts errors or omissions.

The federal district court for the Southern District Court of Ohio held that Chrysler was not obligated to defend or indemnify Sonic in the underlying lawsuits.

In support of its holding, the court cited the decisions in TIG Insurance v. Joe Rizza Lincoln–Mercury, Inc., 2002 WL 406982 (N.D. Ill. Mar.14, 2002) and Heritage Mut. Ins. Co. v. Ricart Ford, Inc., 105 Ohio App.3d 261, 663 N.E.2d 1009 (Ohio Ct. App.1995). However, the TIG and Ricart Ford cases were not exactly on point. The policies at issue in TIG and Ricart Ford only required the insurer to “pay all sums the insured legally must pay as damages solely by operation of” TILA (in TIG) and “damages solely due to” TILA (in Ricart Ford). Based on this restrictive policy language, the courts in TIG and Ricart Ford held the insurer had no obligation to defend or indemnify the dealership because the underlying complaints, although alleging violations of the TILA, did not seek damages under the TILA.

By contrast, the similar provisions of the policy issued to Sonic obligated Chrysler to pay “all sums an insured legally must pay as damages … resulting from … a civil violation of” TILA.  This “resulting from” language was much broader in scope than the policy language interpreted in TIG or Ricart Ford.  Nonetheless, the court noted that “[a]pplying the TIG Insurance analysis to this case, Sonic would not have coverage under the TILA Provisions in the Chrysler Insurance Policies because the [Florida] plaintiffs sought damages under the FDUTPA and the [North Carolina] plaintiffs sought damages under the NCUDTPA and the S.C. Dealers Act.”

In denying coverage, the court in Sonic further noted that “the focus of the Underlying Suits was on deceptive and unlawful practices, not on purported violations of federal or state statutes that regulate disclosures required to complete consumer financing or leasing agreements.” In support, the court pointed out that the “plaintiffs sought to certify classes of all customers who purchased or leased a vehicle with the Etch product, regardless of whether the customers executed financing or leasing agreements with Sonic to do so.” This distinction was certainly relevant to the issue of whether Chrysler Insurance would be obligated to indemnify Sonic for the amounts Sonic paid in settlement (the court’s opinion does not indicate whether the settlement agreements segregated the portion of the damages paid which were attributable to the dealerships’ alleged failure to disclose the price of the Etch product as opposed to the portion attributable to Etch being allegedly overpriced or essentially valueless).  However, the distinction would not seem to be particularly relevant to the determination of whether Chrysler was obligated to defend the dealerships in the lawsuits.  Most, if not all, jurisdictions subscribe to the view that a liability insurer has an obligation to defend a cause of action whenever there is any possibility the insurer would be obligated to indemnify. Inasmuch as the damages sought under the UPTA and NCUDTPA in the underlying lawsuits allegedly “resulted from” a violation of the TILA, the court could have easily decided that Chrysler was obligated to defend (but perhaps not indemnify) Sonic in the underlying lawsuits.

The Sonic court also denied coverage on the alternate basis that the underlying lawsuits did not allege any “negligent act or error or omission” as required by the insuring clause:

The TILA Provisions provided coverage for only “an alleged or actual negligent act or ‘error or omission.’”  The Policies defined “errors and omissions” as “a mistake, oversight, miscalculation or clerical error, which occurs as an unintentional exception to the standard practice or procedure of the insured.” The Court agrees with Chrysler Insurance and Great American that the [underling complaints] alleged intentional misconduct by Sonic. * * * Sonic does not identify allegations of negligent misconduct or errors or omissions made against it in the . . . pleadings. * * * Sonic argues that Chrysler Insurance also had a duty to defend pursuant to the TILA Provisions in the Chrysler Insurance Policies because the [complaints] alleged that Sonic violated TILA and such allegations could be established by negligent conduct. The Court does not agree. * * * Neither [complaint] included express allegations against Sonic based on negligent conduct or errors or omissions. Sonic cannot obtain coverage based on a theory that the plaintiffs in the Underlying Suits could have alleged claims based on negligent conduct when, in fact, plaintiffs alleged only intentional misconduct by Sonic.

As noted in a previous article on this blog, a consumer’s allegations regarding a dealer’s level of culpability should not control the insurer’s obligations to defend and indemnify TILA or CLA claims because the TILA and CLA impose strict liability.  (See,Should an Auto Dealer Insurer Defend an Auto Dealer Against ‘Intentional’ Violations of Federal and State Credit Sale and Leasing Disclosure Laws?). It seems incongruous to limit coverage to negligent acts when the risks insured under the policy are not based on negligence and allegations of negligence are not likely to appear in pleadings. The auto dealer purchases statutory errors and omissions coverage for TILA and CLA to protect itself against liability under the TILA and CLA and cannot control whether the consumer attaches superfluous assertions of wrongful intent to those claims. While insurers should be required to defend or indemnify an auto dealer who has engaged in conduct with the intent to cause consumer harm or evade the law, the determination should not be based on the consumer’s pleadings. Rather, the determination of whether Sonic was entitled to a defense probably should have turned on the applicability of the wrongful conduct exclusion in the Chrysler policies. The exclusion barred coverage for “Dishonest, malicious, fraudulent, criminal, deceptive, malicious or intentional act or omission.” The duty-to-defend analysis in Sonic should have considered whether, for example, the dealerships acted with the specific intent to cause consumer harm (or evade truth-in-lending requirements) or acted with knowledge that either of such harmful consequences was substantially certain to result from their conduct.

Although the plaintiffs’ pleadings in Sonic contained numerous assertions of intentional wrongdoing, it is not entirely clear, from the opinion, whether the dealerships acted with the intent to cause consumer harm or acted with knowledge that consumer harm was “substantially certain” to occur (assuming that is the correct standard to use when addressing the wrongful acts exclusion). On the one hand, the consumers’ retail installment contracts did not separately disclose the charge of the Etch product. However, the opinion does not indicate whether the charge was disclosed to consumers in their purchase agreements or other pre-delivery documents that were presented to, and executed by, consumers. If the charge was disclosed to consumers prior to consummation of their transactions, the insurer would have had some difficulty in proving Sonic intended consumer harm. Whether Sonic acted with the intent to evade the law also cannot be gathered from the plaintiffs’ pleadings. The requirements of the TILA and state retail installment sales act with respect to the Etch product were not addressed in the opinion. Sonic may have, for example, been operating under the belief that the charge for Etch product could be included in the “cash sales price” of the vehicle – an amount which was disclosed to consumers in the itemization of amount financed section of their retail installment contracts.  In any event, the determination of whether Sonic was entitled to a defense probably should have been based on an analysis of the actual facts compared to the wrongful conduct exclusion in the Chrysler policies, not on the consumer’s superfluous assertions of wrongful intent.

This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney. Gregory J. Johnson ©All rights reserved. 2014.

The Auto Dealer Liability Policy: Analyzing Coverage for Statutory Acts, Errors or Omissions Claims (TILA, CLA, FCRA, ECOA, FTC, GLB, CFA & UDTPA)


In previous posts, I’ve discussed the new Auto Dealers Coverage Form (“ADCF”) policy which ISO developed to replace the Garage Liability Policy in late 2013. Prior blog articles include:

The Comprehensive Guide to the 2013 Auto Dealer’s Coverage Form (ADCF”)

The ADCF Policy: The “Auto Dealer Operations” Trigger

Auto Dealer’s Coverage Form: the Difference between “Occurrence” and “Claims-Made” Coverage for Violations of Federal and State Consumer Protection Laws

Auto Dealer Coverage: No Coverage for Violation of FTC Used Car Buyer’s Guide Regulation

Auto Dealer (Garage) Policy: Wrongful Repossession Claims not Covered

Should an Auto Dealer Insurer Defend an Auto Dealer Against “Intentional” Violations of Federal and State Credit Sale and Leasing Disclosure Laws?

One of the most significant differences between the Garage Liability Policy and the new ADCF policy is the addition of “Acts, Errors or Omissions” coverage in Section III of the ADCF policy. This optional liability coverage is primarily designed to protect the auto dealer against claims resulting from the dealer’s violation of certain specified consumer protection laws that regulate the dealer’s finance and insurance operations such as the Truth in Lending Act (“TILA”) and Regulation Z, its implementing regulation, Consumer Leasing Act (“CLA”) and Regulation M, its implementing regulation and Title IV Odometer Requirements of the Motor Vehicle Information and Cost Savings Act (Federal Odometer Act (“FOA”)). Prior to the ADCF policy, most auto dealer insurers offered coverage for these risks under statutory errors and omissions endorsements which varied in scope from insurer to insurer.  (Auto dealer insurers who do not subscribe to ISO continue to use their own policy forms).

Historically, auto dealer insurers have offered protection against a larger assortment of consumer protection laws than described in the ADCF policy. The ADCF policy does not, for example, insure violations of the Federal Trade Commission’s Used Car Buyer’s Guide (which can give rise to a private cause of action under the Magnusson-Moss Warranty Act), prior vehicle damage disclosure statutes or aftermarket parts disclosure statutes. The ADCF policy also excludes coverage for liability resulting from the Fair Credit Reporting Act (“FCRA”), Gramm-Leach-Bliley Act (“GLB”) and damages which relate to violations of the Equal Credit Opportunity Act (“ECOA”), Federal Trade Commission (“FTC”) Privacy and Safeguards Rule, Telephone Consumer Protection Act (“TCPA”), Junk Fax Prevention Act (“JFPA”), CAN-SPAM Act and various FTC rules and regulations.

This article provides a general overview of the insuring clause in Section III of the ADCF policy in the context of truth-in-lending and truth-in-leasing claims.  Understandably, there have been no reported decisions interpreting the acts, errors or omissions coverage of the ADCF policy. However, case law interpreting pre-ADCF statutory errors and omissions coverage will provide guidance on the new policy form. Case law interpreting pre-ADCF policy forms will be the subject of a future article.

The ADCF Policy Insuring Clause

The insuring clause in Section III of the ADCF policy obligates the auto dealer insurer as follows:

We will pay all sums that an “insured” legally must pay as damages because of any “act, error or omission” of the “insured” to which this insurance applies and arising out of the conduct of your “auto dealer operations”, but only if the “act, error or omission” is committed in the coverage territory during the policy period.

The policy defines “act, error or omission” to mean “any actual or alleged negligent act, error or omission committed by an “insured” in the course of your “auto dealer operations” arising: [o]ut of an “insured’s” failure to comply with any local, state or federal law or regulation concerning the disclosure of credit or lease terms to consumers in connection with the sale or lease of an “auto” in your “auto dealer operations”, including, but not limited to, the Truth In Lending and Consumer Leasing Acts.

Pre-ADCF Policy Insuring Clauses

As a preliminary matter, the insuring clause in Section III of the ADCF policy should be contrasted with insuring clauses under prior policy forms.  Historically, auto dealer liability insurers have offered statutory errors and omissions coverage under insuring clauses obligating the auto dealer insurer to pay:

[A]ll sums which the insured shall become legally obligated to pay as damages in an action brought solely under 15 U.S.C. Sec. 1640 (Consumer Credit Protection Act-Public Law 90-321, Title I, as amended), because of error or omission during the policy period in complying with any requirement imposed under 15 U.S.C., Section 1631 et seq.

[A]ll sums which the INSURED shall become legally obligated to pay as damages solely by operation of Section 130, Civil Liability, of Title 1 (Truth in Lending Act) of the Consumer Credit Protection Act (Public Law 90-321; 82 State 146, et seq.) because of error or omission in failing to comply with said section of said Act.

[A]ll sums which you are legally obligated to pay as “damages” solely because of negligent acts, errors or omissions in failing to comply with federal, state or local statutes or regulations specifically pertaining to truth in lending, including 15 USC 1601 et seq.

[A]ll sums the insured legally must pay as damages…because of [“any claim or suit filed against you…by or on behalf of…a customer…because of an alleged violation during the Coverage Part period, of any federal, state or local…truth-in-lending or truth-in-leasing law”].

[A]ll sums an “insured” legally must pay as “damages” arising from an “occurrence” because of an alleged or actual negligent act or “error or omission” by an ‘insured’ occurring during the policy period of this policy and resulting from … a civil violation of any federal, state or local statute that regulates specific disclosures required to complete . . . [c]onsumer financing agreements . . . [or] . . . [c]onsumer leasing agreements”.

[A]ll sums for which the “insured”…becomes legally obligated to pay as damages arising solely from an “occurrence” involving any negligent act, error or omission committed by the “insured” in failing to comply with [TILA] or any State law on Truth in Lending”.

Analyzing suits under such provisions can be complex. While it is not difficult to identify a cause of action seeking damages under the federal TILA or CLA, coverage under the ADCF policy is not limited to TILA or CLA claims. (Compare to the first two insuring clauses cited above which restricted coverage to “damages in an action brought solely under” TILA.) The ADCF policy extends coverage to any local, state or federal law or regulation concerning the disclosure of credit or lease terms to consumers….” Thus, the policy may extend coverage for violations of state motor vehicle retail installment sales acts (which generally require disclosure of the same credit or lease information required to be disclosed under the federal TILA or CLA), uniform consumer credit code or any statute or regulation that has the same purpose and objective as the TILA or CLA, so long as the specific statute or regulation alleged in the complaint “concerns” disclosure of credit or lease terms. The term “concerning” is a broad term that is similar to “involving” or “connected with” and is probably broader in scope than other prepositions or prepositional phrases often used in insurance policies, such as “under,” “because of,” “arising from,” or “resulting from”, which are quite broad themselves.

Embedded Claims

In addition, a consumer’s complaint may contain an “embedded” truth-in-lending or truth-in-leasing claim.  That is, the consumer may allege a violation of the TILA or CLA (or state motor vehicle retail installment sales law) as a predicate to establish liability under a consumer protection statute which prohibits retailers from engaging in unfair, dishonest or deceptive trade practices such as a Consumer Fraud Act (CFA) or a Uniform Deceptive Trade Practices Act (UDTPA). Generally, CFA and UDTPA claims should not trigger coverage because they do not constitute a truth in lending or truth in leasing law and their purpose differs from the purpose and objectives of the TILA or CLA. Rather, CFA and UDTPA statutes generally apply to all retail industries, are generic in scope and do not impose any affirmative obligations on retail sellers to disclose any specific credit or lease terms. Although there may be occasional overlap in the effect of the statutes, CFA and UDTPA legislation usually has a much more general purpose than truth-in-lending and truth-in-leasing statutes – i.e., to prevent unfair, dishonest and deceptive practices in all consumer transactions.  There have been cases involving embedded truth-in-lending claims under pre-ADCF policies which will be discussed in a future article.

Borrowing Statutes

However, some consumer protection statutes contain “borrowing” provisions. A “borrowing” provision is one which provides that a violation of another statute will constitute a violation of the consumer protection statute such that the violation is independently actionable under the consumer protection statute. An example of a borrowing statute is California’s Unfair Competition Law (UCL). “By proscribing ‘any unlawful’ business practice, section 17200 of the UCL ‘borrows’ violations of other laws and treats them as ‘unlawful practices’ that the UCL makes independently actionable.” Cel– Tech Communications, Inc. v. Los Angeles Cellular Telephone Co., 20 Cal.4th 163, 180, 83 Cal.Rptr.2d 548, 973 P.2d 527 (1999). See, also, Perez v. Rent– A– Center, Inc., 186 N.J. 188, 892 A.2d 1255 (2006) (holding that a violation of the New Jersey Retail Installment Sales Act (“RISA”), N.J.S.A. 17:16C–1, et seq. could be asserted under the New Jersey Consumer Fraud Act (“CFA”), N.J.S.A. 56:8–1, et seq., because the violation of the RISA constituted “unlawful conduct” under the CFA). Whether a cause of action alleging a violation of a truth-in-lending or truth-in-leasing law in a cause of action under a borrowing statute obligates an auto dealer insurer to defend and indemnify the auto dealer has not been the subject of any reported decisions. The auto dealer would no doubt take the position that the ADCF policy extends coverage for such claims on the basis that any damages that may be awarded under the borrowing statute constitute damages “because of” the dealership’s “failure to comply with any local, state or federal law or regulation concerning the disclosure of credit or lease terms to consumers.”

General Three-Part Analysis

While the determination of whether a cause of action falls within the insuring clause is dependent on the precise language of the insuring clause, the following three-part test is a useful guide. In addition to affording coverage when (1) the statute or regulation which is the subject of the cause of action is itself described in the insuring clause, the ADCF policy may also provide coverage when (2) the statute or regulation which is the subject of the cause of action has as its purpose the same objectives as a statute or regulation described in the insuring clause; or (3) the statute or regulation which is the subject of the cause of action contains a provision which “borrows” violations from other statutes and the borrowed statute is either described in the insuring clause or has as its purpose the same objectives as a statute or regulation described in the insuring clause.

It is important to note that while a specific statute or regulation may qualify for coverage under the insuring clause, the relief sought in that particular cause of action must also qualify for coverage.  A consumer’s complaint will invariably seek several different types of relief such as actual damages, statutory damages, equitable remedies (rescission and/or restitution), penalties and injunctive relief and possibly punitive damages. Each element of relief sought must be analyzed to determine whether it falls within the insuring clause or is excluded by other provisions of the policy or barred by public policy of the applicable jurisdiction.  The types of damages which are recoverable under the Acts, Errors and Omissions coverage will be discussed in a future article.

As noted above, there have been no reported decisions interpreting the acts, errors or omissions coverage of the ADCF policy. ISO came out with the policy in late 2013.  However, case law interpreting pre-ADCF statutory errors and omissions coverage provides guidance on the new policy form.   This case law will be the subject of a future article on this blog.

This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney. Gregory J. Johnson ©All rights reserved. 2014.

Minnesota Bad Faith in First-Party Benefits: Recap of Bad Faith Litigation


In 2008, the Minnesota Legislature passed a statute, Minn. Stat. § 604.18, that limits liability for “bad-faith” denial of first-party insurance policy benefits.  This article summarizes the reported case law, all from the Minnesota Court of Appeals and all opinions unpublished.

Under the statute, bad faith cannot be pled in the complaint. Rather, after filing suit, the plaintiff must move to amend the complaint by filing a motion based on affidavits establishing prima facie evidence of “the absence of a reasonable basis for denying the benefits of the insurance policy” and “that the insurer knew of the lack of a reasonable basis for denying the benefits of the insurance policy or acted in reckless disregard of the lack of a reasonable basis for denying the benefits of the insurance policy.” Minn. Stat. § 604.18, subd 2(a). If the court finds prima facie evidence in support of the motion, the court may grant the policyholder permission to amend the complaint to pursue a bad faith claim.

If the jury returns a verdict in the plaintiff’s favor, the court (not the jury) determines whether there was “bad faith.”  If so, the court is allowed to add bad-faith damages as taxable costs to the jury award. Bad faith awards are limited to the lesser of: (1) one-half of the proceeds awarded by the jury in excess of the amount offered by the insurer at least ten days before trial began, or (2) $250,000. The court may also award “reasonable attorney fees actually incurred to establish the insurer’s violation” of the statute, but fees are capped at $100,000. Punitive damages are not available under the law. Minn. Stat. § 604.18, subd 3(a).

Exemptions

The law exempts political subdivisions providing self-insurance and pools and the Joint Underwriting Associations operating under Ch. 62F or 62I. Workers’ compensation policies and written agreements of health carriers are also exempt.

Effective Date

The statute became effective on August 1, 2008 “and applies to causes of action for conduct that occurs on or after that date.” 2008 Minn. Laws ch. 208, § 2, at 524.

In Crawford v. State Farm Mut. Auto. Ins. Co., 2012 WL 6554434 (Minn. Ct. App. Dec. 17, 2012), State Farm denied no-fault benefits to Crawford in January 2004. In an attempt to argue the statute applied to her claim, Crawford argued that State Farm engaged in “continuing conduct” after August 1, 2008 by offering to settle the lawsuit for an amount less than that ultimately awarded by the jury. The appellate court rejected the argument. Because the relevant conduct is the insurer’s denial of benefits (see Minn. Stat. § 604.18, subd. 2(a)) and State Farm denied benefits long before the effective date of Minn. Stat. § 604.18, the district court did not abuse its discretion by denying Crawford’s motion to amend the complaint to add a bad faith claim.

Procedural Requirements

 To add a claim of bad faith, the plaintiff must file a formal motion to amend the complaint. In Krupke v. North Star Mut. Ins. Co., A12-1422, 2013 WL 1188015 (Minn. Ct. App. Mar. 25, 2013), the court rejected plaintiff’s bad faith arguments because the plaintiff did not amend her complaint to seek recovery under Minn. Stat. § 604.18, subd. 4(a) (requiring a litigant to amend her complaint to seek recovery for bad-faith denial of first-party insurance claims). See also Greene v. W. Bend Mut. Ins. Co., 2011 WL 292151 (Minn. Ct. App. Feb. 1, 2011) (denying request to amend complaint to plead relief under bad faith statute made in memorandum in response to insurer’s motion for summary judgment as opposed to formal motion to amend).

Standard: “Fairly Debatable”

The majority of states with statutes similar to Minn. Stat. § 604.18 have adopted a “fairly debatable” standard when evaluating an insurer’s denial of benefits. Friedberg v. Chubb & Son, Inc., 800 F.Supp.2d 1020, 1025 n. 1 (D.Minn.2011).

 The Minnesota Court of Appeals applied the “fairly debatable” standard in Homestead Hills Homeowner Ass’n v. Am. Family Mut. Ins. Co., 2012 WL 5896829 (Minn. Ct. App. Nov. 26, 2012), which involved a hail damage claim. Homestead Hills Homeowner’s Association sued after American Family denied coverage for damage to several units in the association. Thereafter, Homestead filed a motion to amend the complaint to allege bad faith. The trial court denied the motion, concluding prima facie evidence did not exist to establish bad faith on the part of American Family.

The relevant facts were as follows: In August 2009, an adjuster from American Family inspected five of Homestead’s roofs and stated that “in his opinion, each of the five … roofs had suffered hail damage as a result of the [July storm.]” The following day, a supervising adjuster from American Family led a second inspection of three additional roofs. After the second inspection, the supervising adjuster determined that the initial adjuster “had been incorrect in his assessment.” The supervising adjuster stated that the damage was caused by a “manufacturing defect” in the shingles and there was “no hail damage that would result in a claim.” The initial adjuster participated in the second inspection and “never disagreed with any statements made by the [s]upervising [a]djuster.”

The Minnesota Court of Appeals upheld the trial court’s ruling. In light of the supervising adjuster’s conclusion that Homestead’s roofs were damaged by a manufacturing defect rather than hail, Homestead’s hail damage claim was “fairly debatable.” As a result, Homestead failed to establish prima facie evidence in support of its motion to amend and could not pursue a bad faith claim against American Family.

In N. Nat. Bank v. North Star Mut. Ins. Co., 2012 WL 4052835 (Minn. Ct. App. Sept. 17, 2012), review denied (Minn. Nov. 27, 2012), the trial court determined the plaintiff was entitled to recover bad faith damages under Minn. Stat. § 604.18, based upon North Star’s “not agreeing to the appraisal process to resolve the claim” and “for the delay in making payment.”

Initially, North Star adjusted the loss and tendered payment of $118,847.40 to plaintiff. At some later point, plaintiff had an independent appraisal performed, but did not share the results with North Star. Two years after the loss, plaintiff presented an appraisal demand. North Star resisted an appraisal hearing based on its interpretation that plaintiff was not an “insured” within the meaning of the policy for purposes of the appraisal process. Plaintiff filed a motion to compel appraisal proceedings with the district court and prevailed on the issue. Once the arbitration panel made its award, North Star deposited funds with the district court in the amount of the difference between the appraised ACV at the time of the loss and what it had already paid.

The Minnesota Court of Appeals reversed the district court’s ruling that plaintiff was entitled to bad faith damages from North Star. The appellate court held that North Star’s initial position on the availability of appraisal did not expose it to bad faith:

 The only incorrect position taken by [North Star] during these proceedings was its initial resistance to the appraisal hearing based on its interpretation that appellant was not an “insured” within the meaning of the contract for purposes of the appraisal process. Appellant prevailed on that issue. It was on this basis that the district court properly determined appellant to be the prevailing party. However, the majority of the states with statutes similar to Minn. Stat. § 604.18 have adopted a “fairly debatable” standard when evaluating an insurer’s denial of benefits. Friedberg v. Chubb & Son, Inc., 800 F.Supp.2d 1020, 1025 n. 1 (D.Minn.2011). Although ultimately found to be incorrect by the district court, under the unique circumstances of this case, [North Star’s] position on the availability of appraisal was “fairly debatable.

The appellate court also rejected bad-faith damages based on North Star’s delay in making payment of the full ACV, finding the delay was primarily attributable to the plaintiff. Almost two years had passed after the date of the loss before plaintiff presented an appraisal demand. Nothing in the record indicated that, prior to requesting the appraisal, plaintiff had even informed North Star it had obtained a different valuation of the loss. “Thus [North Star] could not possibly have understood that there was disagreement on the value of the loss until its receipt of appellant’s motion to compel appraisal proceedings.”

In Bernstrom v. Am. Family Mut. Auto. Ins. Co., 2012 WL 1970073 (Minn. Ct. App. June 4, 2012), review denied (Aug. 7, 2012), the Bernstroms contended that American Family acted in bad faith when it offered to settle their underinsured motorist (UIM) claim for $15,000, knowing that they were entitled to the UIM policy limits of $50,000. The Bernstroms rejected the offer and moved to amend their complaint to add a claim for bad faith pursuant to Minn. Stat. § 604.18. The district court granted the motion.

The jury awarded Bernstrom over $425,000 ($100,000 for past pain, disability, and emotional distress, $2,176.84 for past wage loss, $23,526.87 for past health care expenses; $200,000 for future pain, disability, and emotional distress, $3,000 for loss of future earning capacity and $125,000 for future health care expenses). The jury also awarded Gordon Bernstrom $25,000 for loss of consortium. The district court entered judgment in favor of respondents for the UIM policy limits of $50,000 and then held an evidentiary hearing on the bad-faith claim. The Bernstroms testified, and they also offered expert testimony on insurance claims-handling practices. American Family presented its in-house counsel, who made the claims decisions, and an expert who opined that it had acted reasonably in denying the claim for policy limits.

The district court issued an order denying the bad-faith claim. The district court found the Bernstroms had “not shown by a preponderance of evidence” that American Family lacked a reasonable basis for denying payment of full policy benefits.

On the contrary, the district court found a reasonable basis existed “at least” because of pre-existing-condition evidence in testimony of Dr. Damle and report of Dr. Starzinski. The district court also noted “the conservative venue” and the need for a large verdict to permit recovery over benefits already paid. The court emphasized that American Family had not denied the UIM claim, but rather had offered to settle the claim for $15,000, which American Family believed was an appropriate settlement, given the Bernstroms’ previous receipt of $20,000 in no-fault benefits under their own policy and $45,000 under the negligent driver’s liability policy. The court also noted that American Family had relied on the advice of its counsel — who had represented it in both the liability and UIM suits — to determine that the $15,000 offer was reasonable.

On appeal, the Bernstroms argued the district court erred by disregarding the evidence favoring a high damages recovery and in particular the medical opinions that the injuries were caused by the accident, rather than the preexisting condition. They also asserted that American Family acted in bad faith by failing to adequately investigate their UIM claim. The Bernstroms asserted that, under the Wisconsin case law from which Minnesota’s statutory language is derived, an insurer must conduct an adequate investigation in order to have a reasonable basis for denying a claim. See, e.g., Weiss v. United Fire & Cas. Co., 197 Wis.2d 365, 541 N.W.2d 753, 757 (Wis.1995) (explaining that first prong of test requires evaluation of insurer’s investigative efforts). According to their claims expert, the deficiencies in American Family’s investigation of the UIM claim included the failure to depose Bernstrom during the UIM proceedings, failure to ever depose Gordon Bernstrom, and failure to request a third IME in connection with the UIM proceedings.

The Minnesota Court of Appeals rejected these arguments. First, the district court and appellate court acknowledged the medical opinions stating the injuries were caused by the accident, but nevertheless found that they did not establish the lack of a reasonable basis for American Family’s actions, given the conflicting evidence regarding causation.

Second, while the court did not necessarily agree that Minn. Stat. § 604.18 requires an adequate investigation as a separate element, it agreed with the district court that the Bernstroms had not shown that American Family’s investigation was inadequate. During the entire course of the UIM claim and UIM litigation, American Family had the benefit of access to and knowledge of the complete discovery and investigation previously conducted in the underlying liability claim and access to all of Bernstrom’s medical records, employment records, and tax returns. It also had the transcript of Bernstrom’s deposition from the liability proceedings and its counsel had also met with Gordon Bernstrom. The Berstrom’s own expert conceded that it would be a judgment call whether an insurance company employing the same outside counsel that it did for a liability suit would choose to re-depose the same plaintiff in a subsequent UIM suit.

On this record, the district court did not clearly err by finding that appellants had “not shown by a preponderance of the evidence that [American Family] failed to conduct a reasonable investigation.”

This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney. Gregory J. Johnson ©All rights reserved. 2014.

Jury Awards Plaintiff $326,000 for Emotional Distress Claim Against Insurer Resulting From Bad-Faith Denial of Claim


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A Los Angeles County jury recently awarded a plaintiff a large judgment for a bad faith denial of insurance benefits and emotional distress claim following the insurance company’s failure to provide benefits under its policy. In White v. GEICO Indemnity Company, the plaintiff Panorea White owned an automobile insured by the defendant GEICO. In July of 2010 she was involved in an accident causing damage to her vehicle and repairs estimated at a mere $3,500. GEICO denied the plaintiff’s first-party claim, alleging that White made a material misrepresentation in reporting the accident and that the damage to the vehicle was inconsistent with the accident report. GEICO denied coverage to the other party involved in the accident, resulting in a lawsuit being filed against White. That suit was defended by GEICO under a “reservation of rights” clause and was settled. Due to GEICO’s denial of her claim, White was forced to…

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Known Injury or Damage Exclusion not Applicable in Case of Continuing and Progressive Water Infiltration Resulting from Defective Construction


I recently posted an article, CGL Coverage:  “Known Injuries or Damages” in Minnesota and Beyond”, addressing the “Known Injury or Damage” provision in CGL policies.  In August 2014, the Connecticut Supreme Court addressed the provision in the context of a construction defect case involving ongoing water infiltration issues in Travelers Cas. & Sur. Co. of Am. v. Netherlands Ins. Co., 312 Conn. 714, 95 A.3d 1031 (2014).  Although the insured contractor was placed on notice of the infiltration problems before the policy inception date, the court held the Known Injury or Damage provision did not bar coverage because extrinsic evidence of when the insured was placed on notice could not be used and the underlying complaint did not “specify exactly” when the insured was first placed on notice of the problem.

In 1994, the state of Connecticut contracted with Lombardo to perform masonry for the construction of the law library, which was completed in 1996. In 2008, twelve years after construction was completed, the state sued Lombardo and other entities seeking to recover approximately $18 million because of continuing and progressive water intrusion in the library. Travelers, which insured Lombardo from 1994 to 1998 agreed to defend but Netherlands, which insured Lombardo from 2000 to 2006, refused to defend.

Travelers brought a declaratory judgment against Netherlands. The trial court declared that Netherlands was obligated to defend Lombardo, and pay to Travelers its pro rata share of the costs incurred in defending Lombardo in a suit.  The trial court rejected Netherlands’ reliance on the known injury or damage clause because “the underlying complaint [did] not state with certainty when Lombardo was aware of the actual damage.”

Netherlands appealed and raised numerous issues. Among others, Netherlands argued the “known injury or damage” exclusion in its CGL policies barred coverage. Netherlands claimed that Lombardo had been on notice of problems with the law library “on or before January, 2000,” and, as such, the exclusion applied and barred coverage.

The CGL policies Netherlands issued to Lombardo provided that insurance only applied if:

Prior to the policy period, no insured listed under Paragraph 1. of Section II—Who Is An Insured and no “employee” authorized by you to give or receive notice of an “occurrence” or claim, knew that the “bodily injury” or “property damage” had occurred, in whole or in part. If such a listed insured or authorized “employee” knew, prior to the policy period, that the “bodily injury” or “property damage” occurred, then any continuation, change or resumption of such “bodily injury” or “property damage during or after the policy period will be deemed to have been known prior to the policy period.

“Bodily injury” or “property damage” which occurs during the policy period and was not, prior to the policy period, known to have occurred by any insured …includes any continuation, change or resumption of that “bodily injury” or “property damage” after the end of the policy period.

“Bodily injury” or “property damage” will be deemed to have been known to have occurred at the earliest time when any insured . . .:

(1) Reports all, or any part, of the “bodily injury” or “property damage” to us or any other insurer;

(2) Receives a written or verbal demand or claim for damages because of the “bodily injury” or “property damage”; or

(3) Becomes aware by any other means that “bodily injury” or “property damage” has occurred or has begun to occur.

The Connecticut Supreme Court first held the underlying complaint alleged an “occurrence” and “property damage” within Netherlands’ policy periods: “as we recently decided in interpreting identical CGL policy language in [Capstone Building Corp. v. American Motorists Ins. Co., 308 Conn. 760, 67 A.3d 961 (2013)] the “occurrence” is the defective work, whereas the “property damage”—in this case water intrusion—results from that occurrence.” Netherlands, 95 A.3d at 1054.  The allegations of the underlying complaint alleged “property damage” through the Netherlands’ policies:

We conclude that the underlying complaint alleges property damage that triggered Netherlands’ duty to defend Lombardo. Netherlands’ policies covered periods from August 31, 2000 until June 30, 2006. Although the construction of the law library was completed in 1996, the problems began in the “months and years” that followed the state’s occupancy on January 31, 1996, and the “water intrusion proved to be continuing and progressive” into the 2000s, when the “state retained forensic engineers to investigate the full extent and likely causes of the problem.” Thus, the property damage alleged in the underlying complaint—however broadly worded—extended into Netherlands’ policy periods.

The court next addressed Netherlands’ claim that the “known injury or damage” exclusion barred coverage.  Netherlands claimed that Lombardo knew about the property damage to the library, at least in part, before Netherlands’ coverage began on August 31, 2000.

In addressing the known injury or damage issue, the court first noted that the outcome was dependent on the language of the policy exclusion, not the common law known loss doctrine. Netherlands, 95 A.3d at 1054 (“[a] state’s narrow formulation of the known loss rule . . . ‘cannot be used to defeat the unambiguous contrary intent of the parties as reflected in the policy language itself’”) (quoting Travelers Casualty & Surety Co. v. Dormitory Authority, 732 F. Supp. 2d 347, 362 (S.D.N.Y. 2010)). “[T]he contractual provision, when it exists, governs independently of the common-law rule, although they may have overlapping effects in certain cases.” Netherlands, 95 A.3d at 1054.

The court next addressed the issue of whether extrinsic evidence, along with the allegations in the underlying complaint, could be used to determine whether the insured knew of the property damage for purposes of the known injury or damage provision applied. If extrinsic evidence was allowed, the known injury or damage provision would no doubt have barred coverage as it was apparent the insured had been placed on notice of the water infiltration problems prior to issuing the policy in August 2006.  The court cited cases from other jurisdictions where courts had allowed the use of extrinsic evidence. See e.g., Tower Ins. Co. v. Dockside Associates Pier 30 LP, 834 F.Supp.2d 257, 266–67 (E.D.Pa.2011) (considering complaint letters to and from insured’s management about water infiltration into condominiums, produced by insurer, in concluding that they are “not … entitled to coverage”); Travelers Casualty & Surety Co. v. Dormitory Authority, supra, 732 F.Supp.2d at 361 (considering letters and other undisputed extrinsic evidence of remediation efforts in holding that, because contractor “became aware prior to the beginning of the policy period that damage to the [f]looring [s]ystem had occurred or had begun to occur, [it] cannot seek coverage for the [f]looring [f]ailure under the terms of the Ohio [c]asualty [p]olicy”).

However, the Connecticut Supreme Court rejected the use of extrinsic evidence, concluding it would be “inconsistent with our well established four corners approach in assessing an insurer’s duty to defend. Netherlands, 95 A.3d at 1055, n. 30 (citing Capstone Building Corp. v. American Motorists Ins. Co., 308 Conn. 760, 67 A.3d 961 (2013)). Having concluded that extrinsic evidence could not be used to determine whether the known injury or damage exclusion applied, the court measured Netherland’s duty to defend against the allegations of the underlying complaint. Although the court acknowledged the complaint allegations “arguably permit a reasonable inference that Lombardo knew of the property damage in the law library prior to the inception of its policies with Netherlands,” the court held that Netherlands was obligated to defend given the well-established maxim that, “[i]f an allegation of the complaint falls even possibly within the coverage, then the insurance company must defend the insured.” Netherlands, 95 A.3d at 1055-56. The court stated:

Although paragraph 43 of the underlying complaint avers that the “defendants were given notice of these [water intrusion] problems and frequently visited the [law] library to ascertain the nature and extent of the problem,” those allegations do not specify exactly when Lombardo received notice, other than to state that the water problems began “[d]uring the months and years” following the project’s completion and the state’s occupancy in January, 1996, and that forensic engineers were retained in the “2000s.” Similarly, the underlying complaint does not state when exactly those engineers’ reports were provided to Lombardo, only that they were at some point. Insofar as Netherlands was not Lombardo’s only insurer during the eight years of the 2000s leading up to the state’s filing of the underlying action, and because we construe insurance policies to afford coverage whenever possible, we conclude that the trial court properly determined that the facts alleged in the underlying complaint do not preclude coverage for purposes of the duty to defend.

In a jurisdiction which allows extrinsic evidence in determining an insurer’s duty to defend, the result in this case may well have been different.

This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney. Gregory J. Johnson ©All rights reserved. 2014.

CGL Coverage: “Known Injuries or Damages” in Construction Defect Litigation


There has been a tremendous amount of construction defect litigation in Minnesota over the past fifteen years which has had a major impact on both the construction and insurance industries. In an effort to slow the tide, commercial general liability (“CGL”) insurers introduced a series of coverage restricting endorsements and provisions which either eliminate coverage for certain types of construction defect claims or significantly reduce the coverage that had generally been since the late 1980’s. This article addresses one such policy provision, the “Known Injury or Damage” exclusion.

Originally introduced by way of endorsement, it was later built into the basic CGL coverage form.  With regard to property damage claims, the Known Injury or Damage provision states that insurance will only apply to “property damage” if:

Prior to the policy period, no insured … knew that … “property damage” had occurred in whole or in part. If such a listed insured … knew prior to the policy period, that … “property damage” occurred, then any continuation, change or resumption of such … “property damage” during or after the policy period will be deemed to have been known prior to the policy period.

…“[P]roperty damage” will be deemed to have been known to have occurred at the earliest time when any insured …:

  1. Reports all, or any part, of the … “property damage” to us or any other insurer;
  2. Receives a written or verbal demand or claim for damages because of the … “property damage”; or
  3. Becomes aware by any other means that … “property damage” has occurred or has begun to occur.

The Known Injury or Damage provision “is known in the insurance industry as the Montrose endorsement because Insurance Services Office, Inc.,  . . . promulgated it in response to the California Supreme Court’s narrow application of the common-law known loss and loss in progress doctrines in Montrose Chemical Corp. of California v. Admiral Ins. Co., 10 Cal.4th 645, 693, 913 P.2d 878, 42 Cal.Rptr.2d 324 (1995), which held that in the context of commercial general liability insurance, a legally insurable risk continued to exist so long as ‘no legal obligation to pay third party claims has been established….’” Travelers Cas. & Sur. Co. of Am. v. Netherlands Ins. Co., 312 Conn. 714, 95 A.3d 1031, 1054, n. 29 (2014).

While the Known Injury or Damage provision is, to a large extent a policy codification of the common law doctrines of “known loss” and “loss in progress” doctrines, it “stands in distinction to that common-law principle; the contractual provision, when it exists, governs independently of the common-law rule, although they may have overlapping effects in certain cases.” Travelers Cas. & Sur. Co. of Am. v. Netherlands Ins. Co., 312 Conn. 714, 95 A.3d 1031, 1054 (2014) (citing Travelers Casualty & Surety Co. v. Dormitory Authority, 732 F. Supp. 2d 347, 362 (S.D.N.Y. 2010)). A “state’s narrow formulation of the known loss rule . . . cannot be used to defeat the unambiguous contrary intent of the parties as reflected in the policy language itself.” Id. Thus, in Dormitory Authority, the court rejected the insured’s argument that known injury exclusion “should be construed in accordance with the known-risk or known-loss doctrine under New Jersey law,” which “does not bar liability for mere knowledge of events that might hypothetically or potentially create liability in the future, but instead, bars coverage only when the legal liability of the insured is a certainty”.

Before addressing case law interpreting the Known Injury or Damage provision,  a review of the common law doctrines is necessary. Establishing a known loss or loss in progress under Minnesota common law has been difficult. Absent proof the insured was on actual notice that a loss had already occurred (“the house burned down”) or a loss was virtually certain to occur (“the house is on fire”), the common law doctrines rarely provide a defense. Whether insurers will fare better under the Known Injury or Damage provision in Minnesota and elsewhere remains to be seen. The “deemed to have been known” language suggests an objective standard of knowledge, as opposed to the common law’s purely subjective standard. However, there has been only one reported Minnesota appellate decision addressing the Known Injury or Damage provision, which is discussed below.

Common Law Known Loss & Loss in Progress Doctrines

A “known loss” is a loss that has already occurred while a “loss in progress” is one involving an ongoing, progressive loss. In Minnesota, the common law doctrine of “known loss,” and its counterpart, the “loss in progress” doctrine, is a fraud-based defense. Domtar, Inc. v. Niagara Fire Ins. Co., 563 N.W.2d 724 (Minn. 1997) (citing Franklin v. Carpenter, 309 Minn. 419, 424-25, 244 N.W.2d 492, 496 (1976); Waseca Mut. Ins. Co. v. Noska, 331 N.W.2d 917, 924-25, n. 6 (Minn. 1983); Oster v. Riley, 276 Minn. 274, 280-81, 150 N.W.2d 43, 48-49 (1967)). “The known loss doctrine has been described as ‘a compilation of practical concepts intended to prevent a windfall for insureds and manifest unfairness for the insurance industry.’” Domtar, Inc., v. Niagara Fire Ins. Co., 563 N.W.2d 724 (Minn. 1997) (quoting Buckeye Ranch, Inc. v. Northfield Ins. Co., 134 Ohio Misc.2d 10, 839 N.E.2d 94, 104 (Ct. Common Pleas 2005)).

Commentators have noted that “losses which exist at the time of the insuring agreement, or which are so probable or imminent that there is insufficient ‘risk’ being transferred between the insured and insurer, are not proper subjects of insurance.” 7 Lee R. Russ & Thomas F. Segalla, Couch on Insurance, § 102:8 at 20 (3d ed.1997). The common law doctrine focuses on the insured’s actual knowledge prior to the application for liability insurance. Domtar, 563 N.W.2d at 731 (Minn. 1997).

The known loss and loss in progress doctrines are two variants of the principle of fortuity. Insurance is intended to insure against unknown, future events. Thus, the known loss defense bars coverage when the putative insured seeks insurance after knowing that the house has burned down while the loss in progress doctrine will bar coverage when the putative insured seeks insurance knowing that the house is in the process of burning down. The “known loss doctrine is a common-law rule that derives from the ‘implicit requirement read into every liability insurance policy that coverage will be provided only for fortuitous losses….’” Travelers Cas. & Sur. Co. of Am. v. Netherlands Ins. Co., 312 Conn. 714, 95 A.3d 1031, 1054 (2014) (quoting 1 B. Ostrager & T. Newman, Handbook on Insurance Coverage Disputes, § 8.02[a], p. 676(16th Ed. 2013)). “[B]y definition, insurance is not available for losses that the policyholder knows of, planned, intended, or is aware are substantially certain to occur”. Id., § 8.02, at p. 673. “[T]he known loss doctrine embraces the fortuity requirement by precluding coverage for a loss known to be certain to create a liability at the time the policy is issued.” Id., § 8.02[c], at p. 685. “[I]n its most simplistic formulation, [the known loss doctrine] states that one may not insure against loss of a building after the building has burned down.” Steadfast Ins. Co. v. Purdue Federick Co., Superior Court, judicial district of Stamford–Norwalk, Complex Litigation Docket, Docket No. X08–CV–02–0191697–S, 2006 WL 1149185 (April 11, 2006) (41 Conn. L. Rptr. 183, 184).

Given its basis in the prevention of fraud in Minnesota, a fundamental requirement of the loss in progress doctrine is that the insured must know that a progressive loss is occurring prior to the inception of the policy. See e.g., Inland Waters Pollution Control, Inc. v. Nat’l Union Fire Ins. Co., 997 F.2d 172, 175-88 (6th Cir.1993) (rejecting argument that doctrine applies regardless of insured’s knowledge, and holding instead that the loss in progress doctrine “operates only where the insured is aware of the threat of loss so immediate that it might fairly be said that the loss was in progress and that the insured knew it at the time the policy was issued or applied for”).

Common Law: Subjective Standard of Knowledge

Under Minnesota common law, the insured’s knowledge will generally be judged by a subjective standard (what the insured actually knew) rather than an objective standard (what a reasonable insured should have known under the circumstances or have reason to know). Domtar, Inc. v. Niagara Fire Ins. Co., 563 N.W.2d 724, 735 (Minn. 1997) (holding whether damages are “expected” by an insured requires a certainty of harm on the part of the insured that is greater than general standards of foreseeability used to impose liability on the insured). This standard does not preclude the use of circumstantial evidence, but proof of “objective indicia” is only permitted in exceptional circumstances. Id. (citing Morton Int’l, Inc. v. General Accident Ins. Co. of Am., 134 N.J. 1, 85-87, 90-95, 629 A.2d 831, 879-80, 882-84 (1993)).

Under the subjective standard, a finding that the insured “reasonably should have known” of an ongoing, progressive loss is insufficient to defeat coverage. Rather, the insured must have had actual knowledge of the ongoing loss for the loss in progress doctrine to apply. A subjective standard is appropriate in light of the doctrine’s history in fraud prevention. It is only when the policyholder has actual knowledge that a fraud can be perpetrated. State v. Hydrite Chemical Co., 280 Wis.2d 647, 671, 695 N.W.2d 816, 829 (Wis.App.2005); Aetna Cas. & Surety Co. v. Dow Chem. Co., 10 F. Supp. 2d 771, 789-91 (E.D. Mich. 1998); United Techs. Corp. v. American Home Assur. Co., 989 F. Supp. 128, 151 (D.Conn.1997). As one court noted: “[T]he purpose of the loss in progress doctrine, preventing fraud, will be served by a subjective knowledge analysis. The insurer is protected because the insured cannot misrepresent its knowledge to the insurer. The insured is protected because the insurer cannot refuse responsibility merely by learning of facts that both parties previously were unaware of.” United Tech Corp., 989 F. Supp. 128, 151 (D. Conn. 1997). “A subjective standard also protects against the misuse of hindsight to avoid indemnification coverage.” Dow Chem. Co., 10 F. Supp. 2d at 789.

Common Law: Knowledge of Actual Loss, Not Acts Which Produced Loss

It is well established that the loss in progress doctrine does not bar coverage simply because an insured knows of an act or omission that might result in a covered loss after the policy is purchased. In Gopher Oil Co v American Hardware Mut. Ins. Co., 588 NW2d 756 (Minn. Ct. App. 1999), American Hardware argued that Gopher State knew that the disposal of oil sludge at its Arrowhead site was causing groundwater contamination. The court disagreed holding that at best Gopher State knew that the oil sludge was unsightly and a risk to surface water; there was no evidence suggesting that it knew the oil sludge disposal was causing groundwater contamination. See also Domtar, Inc. v. Niagara Fire Ins. Co., 552 N.W.2d 738, 747 (Minn.App.1996) (known-loss defense requires evidence that the insured knew of the loss, not that the insured knew of the acts leading to the loss), affirmed in part, reversed in part on other grounds, 563 N.W.2d 724 (Minn.1997); Buckeye Ranch, Inc. v. Northfield Ins. Co., 134 Ohio Misc.2d 10, 23-28, 839 N.E.2d 94, 104 (Ct. Common Pleas 2005) (known loss doctrine does not bar coverage where the insured only knows of an act that someday might result in damages); United Technologies Corp., 989 F. Supp. at 148-52 (although insured may have known of the waste disposal practices that ultimately resulted in environmental contamination, question of fact remained whether it knew at the inception of the policy that those practices would result in contamination); Cincinnati Ins. Companies v. Pestco, Inc., 374 F. Supp. 2d 451 (W.D. Pa. 2004) (known loss doctrine did not apply to bar advertising injury coverage for alleged trade dress infringement, notwithstanding allegation that plaintiff sent insured cease and desist letter prior to policy).

In Buckeye Ranch, 839 N.E.2d 94 (Ct. Common Pleas 2005), one boy sexually assaulted his younger roommate in 1996 while both were long-term residents receiving treatment at The Buckeye Ranch, Inc. (“the Ranch”). The Ranch was a nonprofit institution that provided services, including a residential program, for children and families struggling with emotional, behavioral, and mental health issues. The Ranch was aware of the assault incident in 1996. However, the Ranch conducted an internal investigation, assisted in a criminal investigation, and participated in investigations by various agencies, but ultimately no investigation resulted in “specific allegations” of fault against the Ranch. Several years later, the Ranch was sued and its CGL insurer contended that the claim was barred under the common law known loss doctrine. The court held that these facts did not give rise to a “known loss” defense. The court noted that “[a] risk that the incident might produce a claim for damages can now be appreciated in hindsight. However, there is no “known risk.” Id. at 109. Thus, the Ranch was entitled to coverage under the policy.

One of the clearest cases of a known loss was involved in Crawfordsville Square, LLC. v. Monroe Guar. Ins. Co., 906 N.E.2d 934 (Ind. Ct. App. 2009). In that case, CS operated a shopping mall and in 1998 submitted a purchase agreement on a parcel of land adjacent to the mall which contained several businesses, including a dry cleaning business. Soon thereafter, as part of an environmental audit, CS had subsurface testing performed on the parcel. The testing revealed petroleum and cleaning agent contamination in the land. In September 1998, CS member L.E. Kleinmaier sent a letter to the seller stating: “Clean up [sic] of both petroleum and cleaning agent contamination must happen. The law requires it. We are willing to proceed with the closing provided an escrow account is established with the title company in the amount of $90,000. The title company will hold the funds and make disbursements from time to time to the environmental firm (AEAC) which will perform the clean-up.” CS ultimately agreed to proceed to closing on the Parcel and both the closing and escrow agreements provided, in part, that “[t]he parties have confirmed the existence of petroleum and other contamination of the soil and water on and under the real estate that is residual contamination from the operation of a cleaner and underground storage tanks on the real estate.” In February 1999, CS’s insurance agent contacted Monroe Guaranty, seeking to add the parcel to CS’s existing CGL policy. Although CS’s agent advised Monroe Guaranty that a dry cleaning business was operating on the parcel, neither the agent nor CS advised Monroe Guaranty of the existence or believed existence of dry cleaning contamination at the site. In 2005, an environmental engineering company reported evidence of contamination on the parcel to the Indiana Department of Environmental Management (“IDEM”). The IDEM sent notice of the contamination to CS and requested that it investigate the nature and extent of the contamination. CS, in turn, tendered the claim to Monroe Guaranty under the CGL policy. Monroe Guaranty denied coverage for the claim contending, among other things, that coverage was barred by the known loss doctrine. , CS claimed that it was not actually aware that a loss had occurred, was occurring, or was substantially certain to occur. CS relied on the October 2007 deposition testimony of Kleinmaier where he suggested, in contrast to his September 2008 letter, that CS only knew of a “possibility” of contamination. The trial court rejected CS’ position and granted Monroe Guaranty summary judgment. Indiana Court of Appeals agreed that the known loss doctrine barred the claim, stating:

On September 29, 1998, CS member Kleinmaier sent a letter to Hedrick indicating that “[c]lean up [sic] of both petroleum and cleaning agent contamination must happen. The law requires it….After two successive quarters of below action level reports, the Indiana Department of Environmental Management will issue ‘no further action’ letter is received from the state. [sic.]” Indeed, Kleinmaier’s letter included a request that an escrow account in a specific amount be made available for the clean-up, indicating that CS knew enough regarding the contamination to estimate the cost of its remediation. The communication clearly indicates knowledge of dry cleaning contamination and, by its references to legally-mandated clean-up and IDEM requirements for successful compliance with applicable regulations; that the contamination was at actionable levels. *** [The] letter represents specific knowledge of a loss that had already occurred . . . we conclude that the designated evidence establishes that CS had the required actual knowledge of dry cleaning fluid contamination at actionable levels, which constitutes a known loss.

In addition, the “loss in progress” doctrine will only apply “where the insured is aware of a threat of loss so immediate that it might fairly be said that the loss was in progress and that the insured knew it at the time the policy was issued or applied for”. Inland Waters Pollution Control, Inc. v. Nat’l Union Fire Ins. Co., 997 F.2d 172, 178 (6th Cir.1993). While there is no bright-line test, there is a major distinction between (a) knowledge of a risk or a potential for loss; and (b) knowledge that a loss is virtually certain to occur. Thus, more is required than mere awareness of a potential risk of a loss or of the potential that damages may arise sometime in the future.

In Insurance Co. of North America v. U.S. Gypsum Co., 870 F.2d 148 (4th Cir.1989), the Fourth Circuit held that the insured’s knowledge that its plant was built on a mining site which had suffered several incidents of subsidence over the years did not justify its insurer in denying coverage when an area of more than twenty-one acres collapsed and dropped as much as six feet. Although the insurer could show that other smaller sink holes had appeared from time to time and that the insured periodically hired professionals to evaluate the stability of the site, the insured’s witnesses testified that the “catastrophic subsidence” that occurred was entirely unexpected. On these facts, the court held that the fact that it is known that subsidence will occur does not mean that it will occur during the policy period. Moreover, there is a fundamental distinction between the certainty of subsidence and the certainty of resulting loss. Id. at 152. Significantly, the court went on to reject the insurer’s “loss in progress” argument “for the same reasons.” Id. It concluded that this is not a case where the forces which eventually led to the subsidence and collapse created an immediate threat of loss at the time the policy was issued. Id. at 153.

Common Law: Different Damages or Unrelated Causes not Barred

Similarly, mere knowledge of prior damage is insufficient to establish a defense under the fraud-based loss in progress doctrine where the insured is sued for different damages or there remained uncertainty as to the cause of the prior damage or the scope of damages at the time the insured purchased the liability policy. While “losses stemming from the same cause relating to a previously discovered and manifested loss are included within the ‘loss-in-progress’ rule,” Factory Mutual Ins. Co. as Successor in Interest to Arkwright Mutual Ins. Co. v. Estate of James Campbell, 81 Fed. Appx. 918, 919-20 (9th Cir. 2003), the doctrine does not apply to damages resulting from unrelated causes or damages of different scope or dimension. See e.g., Pines of La Jolla Homeowners Assn. v. Industrial Indemnity, 5 Cal. App. 4th 714, 7 Cal. Rptr. 2d 53 (4th Dist. 1992) (loss in progress rule does not apply as to a distinct item of damage that was not known by insured prior to the policy period); MAPCO Alaska Petroleum, Inc. v. Central Nat. Ins. Co. of Omaha, 784 F. Supp. 1454, 1462 (D. Alaska 1991) republished as corrected at 795 F. Supp. 941 (loss in progress doctrine did not apply to claim of groundwater contamination where insured “believed the problem was localized and capable of remediation”). In Stonehenge Eng. Corp. v. Emp. Ins. of Wausau, 201 F.3rd 296 (4th Cir. 2000), defects in condominium foundations and balconies appeared in 1989. Wausau undertook the risk in 1992-1995, after the owners’ association had formally notified the general contractors of difficulties and solicited a response from their lawyer. The court rejected the known-loss defense. It pointed out that the exact cause of the difficulties with the concrete was not known when coverage was bound. The insured only “knew of the obvious potential for problems with the remaining twenty-eight villa units” by 1992, after four floors had failed and were replaced. “Such knowledge on the part of Stonehenge, however, does not equate to knowledge prior to the effective dates of the three Wausau policies that imposition of liability upon it for construction of the lightweight concrete floors in all of the villa units was substantially certain to occur.” 201 F.3d at 303. The known loss defense did not apply.

The Contractual Known Injury or Damage Provision

Minnesota Decisions

There has been only one published Minnesota appellate decision addressing the Known Injury or Damage provision. In Westfield Ins. Co. v. Wensmann, Inc., 840 N.W.2d 438 (Minn. Ct. App. 2013), review denied (Minn. Feb. 26, 2014), Diseworth at Somerby (“Diseworth”) a planned community consisting of 18 townhome units designed and constructed by Wensmann Homes, appealed the district court’s ruling that Wensmann’s general liability insurer, Westfield, excluded coverage for defective construction work because Wensmann knew of the property damage prior to the inception of the policy.

Diseworth sued Wensmann for negligence and breach of statutory warranties relating to claims of failed arches and water infiltration issues. Each unit had brick arches under the unit’s back deck. All of the buildings were built and occupied before April 1, 2007, the date Westfield issued the commercial general liability (CGL) policy to Wensmann.

Wensmann first became aware of cracks in the brick arches in July 2005 when a homeowner submitted requests for warranty work. The repair work was completed on September 15, 2005 and Wensmann hired a structural engineer to create a design plan for future arches as other arches were cracking and four townhome units had not yet been built. While the arch masonry complaints were documented prior to April 1, 2007, there was no documentation of water infiltration claims before that date.

The Westfield policy contained a known loss provision stating that the insurance only applied to “property damage” if “[p]rior to the policy period, no insured … knew that …‘property damage’ had occurred in whole or in part. If such a listed insured … knew prior to the policy period, that …‘property damage’ occurred, then any continuation, change or resumption of such … ‘property damage’ during or after the policy period will be deemed to have been known prior to the policy period.”

In addressing the known loss coverage issue, the appellate court separated the claimed damages into three classes: damage resulting from brick arches constructed before the new arch design; damage resulting from brick arches that were constructed with the new arch design; and damage resulting from water infiltration issues.

With regard to damages to brick arches constructed before the new arch design, Diseworth argued the exclusion did not apply because the cracks were minor and Wensmann repaired the cracks and, thus, could not have expected future damage. While the court engaged in a lengthy analysis of the issue, the result was clear. There were numerous cracks on different arches prior to the inception of the Westfield policy on April 1, 2007 caused by an improper design (or a lack of any design) and Wensmann was aware of the problem before the Westfield policy went into effect. The typical known loss provision, and that set forth in the Westfield policy, do not require knowledge of the full extent of the property damage.  Rather, the provision excludes coverage where, before the policy was issued, the insured knew that the “property damage had occurred in whole or in part.”  Thus, the known loss exclusion barred coverage for damages to brick arches constructed before the new arch design was implemented.

However, damages to the brick arches constructed with the new arch design in the last four units could not be barred as a matter of law because the known loss provision only excludes damages which are a “continuation, change or resumption” of damage that occurred before the policy inception date.  Because of the changed design, the arch damages to the last four units may have been due to a different cause than the arch damages sustained prior to the policy period.  The district court therefore erred in granting summary judgment as to the arches constructed in the last four units.

The damages resulting from water infiltration was not subject to the known loss exclusion because there was no evidence of water infiltration before the inception of the Westfield policy: “[t]o hold that the cracks in an exterior brick arch provided Wensmann with knowledge that there may be water infiltration resulting from improperly installed windows, doors, and siding would greatly expand the universe of potential claims excluded by an insured’s awareness of a known loss.” The district court therefore erred in granting summary judgment as to the water infiltration claims.

The last two holdings in Westfield are similar to several cases (discussed above) holding the common law known loss/loss in progress doctrines do not apply to damages resulting from unrelated causes or damages of different scope or dimension. See e.g., Pines of La Jolla Homeowners Assn. v. Industrial Indemnity, 5 Cal. App. 4th 714, 7 Cal. Rptr. 2d 53 (4th Dist. 1992) (loss in progress rule does not apply as to a distinct item of damage that was not known by insured prior to the policy period); MAPCO Alaska Petroleum, Inc. v. Central Nat. Ins. Co. of Omaha, 784 F. Supp. 1454, 1462 (D. Alaska 1991) republished as corrected at 795 F.Supp. 941 (loss in progress doctrine did not apply to claim of groundwater contamination where insured “believed the problem was localized and capable of remediation”).

Other Jurisdictions

There is a division of authority with respect to the application of the known injury exclusion when the insured party was alerted to damage prior to the issuance of the policy, attempted remedial measures to address the problem, and learned later that those remedial measures were unsuccessful. See e.g., Essex Ins. Co. v. H & H Land Devel. Corp., 525 F.Supp.2d 1344, 1348 (M.D.Ga.2007) (denying insurer’s motion for summary judgment because there were genuine issues of material fact as to whether insured contractor’s knowledge of property damage on one property was “sufficient to make [it] aware that property damage was occurring” on properties giving rise to claim, and insured “had reason to believe its remedial measures had eliminated the problem of excess runoff”); Desert Mountain Properties Ltd. Partnership v. Liberty Mutual Fire Ins. Co., 225 Ariz. 194, 236 P.3d 421 (Ariz. Ct. App.2010) affirmed, 226 Ariz. 419, 250 P.3d 196 (2011) (holding sufficient evidence that insured contractor “lacked knowledge of the relevant property damage before the policies began” because, although aware of customer complaints about settling houses due to soil compaction made prior to policy period, it believed that those complaints had been resolved and “none of the complaints led [the insured] to believe there was a wide-scale problem with improper soil compaction”): Harleysville Mutual Ins. Co. v. Dapper, LLC, United States District Court, Docket No. 2:09CV794 (M.D. Ala. July 21, 2010) (The insurer had no duty to defend because it “is undisputed that [the insured] received notice of the … property damage [to an adjacent property] directly from [its owner] at least two months before the … property was added to the [insurer’s] policies. The fact [the insured] thought his remediation efforts would resolve the situation does not belie his knowledge of the damage.”).

The Connecticut Supreme Court recently addressed the “Known Injury or Damage” provision is a CGL policy in a construction defect case involving ongoing water infiltration issues in Travelers Cas. & Sur. Co. of Am. v. Netherlands Ins. Co., 312 Conn. 714, 95 A.3d 1031 (2014).  Although the insured contractor was placed on notice of the water infiltration problems before the policy inception date, the court held the Known Injury or Damage provision did not bar coverage because extrinsic evidence of the insured’s knowledge could not be used and the underlying complaint did not state “exactly” when the insured was first placed on notice of the water intrusion problems.  I recently posted a separate article regarding the Netherlands’ decision.

This blog is for informational purposes only. By reading it, no attorney-client relationship is formed. The law is constantly changing and if you want legal advice, please consult an attorney. Gregory J. Johnson ©All rights reserved. 2014.

 

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