December 11, 2006

Uninsured and underinsured employers who bank on never facing an allegation of an unlawful employment practice because they have never been embroiled in such a dispute in the past may be gambling with their own financial futures. Employment-based litigation is not going away anytime soon. The Equal Employment Opportunity Commission (EEOC) remains busy receiving administrative employment discrimination claims. In fiscal year 2005, the EEOC received 75,428 charges of discrimination for all statutes enforced by that agency. [i]

The final tab for employers who are named “defendant” in employment litigation can be astronomical. One lawsuit alleging claims for breach of written employment contract brought by two former employees and officers of a mortgage business resulted in a judgment of $1.8 million in favor of the plaintiffs. [ii] Settlements can also be extremely expensive. On November 22, 2006, the EEOC announced it reached a $2.2 million settlement with JPMorgan Chase & Co. regarding a claim brought under the Americans with Disabilities Act. [iii] Then there are the expenses associated with retaining defense counsel. In a 2005 survey conducted by the National Law Journal, it was reported that billing rates for partners and associates of this nation’s law firms are increasing, and that one defense attorney’s billing rate had reached $1,000 per hour. [iv] Given the potential exposure involving just one of these claims, adequate insurance protection is becoming more of a necessity and less of a luxury for employers.

Unlike insurance policies that afford occurrence-based protection, EPLI is only available in the “claims-made” form. This means that the EPLI policy will only cover losses that the employer knew or should have known about during the timeframe that the policy was in force and perhaps for a short period after the policy expires, so long as the claim was made in a timely manner. Conversely, a property and casualty insurance policy typically provides “occurrences” coverage. Under this scenario, property damage discovered today, but which occurred five years ago under a policy that has long since expired, would still be covered. Because an EPLI policy is of the “claims made” form, the employer should review the policy’s reporting provision to determine the fixed period that the loss must be reported after the expiration of the policy period. The employer should also inquire about additional extending reporting coverage endorsements, which would provide the insured with a buffer period at the end of the policy period to report covered losses.

An EPLI policy constitutes a contract between the carrier and its named insured. When endeavoring to construe the contractual language of the insuring instrument, the employer should not hesitate to seek the assistance of an expert. As one court put it, insurance policies are highly technical documents, and carriers may attach different meanings to the same term. [vii]   

The relationship between the EPLI carrier and its insured is such that the risk of losses involving employment-related claims are transferred from the employer to the insurer. The carrier agrees to defend and indemnify the employer for covered losses in return for the premium paid. The insurer’s duty to defend and likewise to pay legal expenses, however, arises only from an express undertaking as stated in the policy. In this regard, the language of the EPLI policy governs. Where such language is clear and unambiguous, a court will construe the language in accordance with its plain, ordinary and popular meaning. [viii]

When shopping for EPLI coverage, the employer should take note that the policy offering the lowest premium may not be the bargain that it appears to be, if the carrier is having financial problems or has a history of not paying claims in a timely manner. Employers should contact their state’s Department of Insurance and consult other sources to learn about the carrier that they are considering contracting with. They should only deal with companies that are reputable, established and solvent. Additionally, EPLI policy language should be carefully reviewed to evaluate the scope of indemnity afforded under the contract. Efforts should be taken to avoid situations where the insured finds out the hard way that less indemnity was purchased than was presumed. The time to learn that the employer is underinsured should never be when a claim is reported.  In other words, employers should assess the bang that they are getting for their buck before contracting with any EPLI provider. Key variables to consider during the evaluation process include the maximum and per loss amount of coverage, the policy deductible or self-insured portion, the types of losses that are included versus excluded and the manner in which the policy defines “employment practice.” Another critical issue centers on who gets to select defense counsel in the event of a loss. While some policies allow the insured to name defense counsel of its own choosing, others state that the carrier retains the right to name the attorney who will defend the employer.

The insured should also assess its own duties and responsibilities under the EPLI policy. For instance, these policies include a notice provision which will require the insured to timely notify the carrier in the event of a loss. The contract will set forth specific requirements associated with claims reporting, such as that the carrier is to be notified in writing of any loss. The insured who fails to comply with the requirements stated in the notice provision of the claims reporting process does so at its own risk, particularly if the late notice is deemed to have resulted in prejudice to the insurer.[ix] EPLI policies also include a “duty to cooperate” provision which will require the insured to assist the adjuster and defense counsel in the event of a loss, to provide certain information and records to the carrier, to participate in depositions and other pre-trial proceedings and to attend trial. In other words, the insured does not get to walk away from the claim and let the carrier deal with the fall-out simply because coverage is available.

Depending on the size of the organization and the type of business it is in, the employer may opt for EPLI overage that is more expansive in the kinds of claims that are covered. For example, suppose the clear and unambiguous policy language defines covered losses to be limited to those brought by individuals who are retained on a full or part time basis only. Employers who subsequently submit claims involving a subcontractor, independent contractor or leased employee should not be surprised when they are informed by the EPLI adjuster that such claims are excluded from coverage. Thus, employers who retain a flexible workforce comprised of leased or contracted employees should seek out policies that cover these workers. As with any other type of insurance, a larger premium will be charged for greater protection. Nonetheless, the employer should be cognizant of the fact that not every employment practice can be insured. Certain types of losses are simply not covered by carriers. By way of example, most EPLI policies exclude claims based on, arising from, or in any way related to the Fair Labor Standards Act,[x] among other statutes. Likewise, fraudulent, criminal or malicious acts or omissions are generally excluded from these policies.

Litigation may result in situations where the insured and the carrier are embroiled in a dispute over coverage. These lawsuits center on state law claims for first party breach of contract, and possibly a second count for bad faith. Even when this litigation is heard in federal court, such as in diversity of citizenship actions, the issue will be resolved pursuant to governing state law. For instance, in a breach of contract/bad faith action brought in federal court, the judge reviewed Pennsylvania law to address the controversy between the insured and its insurer. With respect to the bad faith count, the court explained that, under Pennsylvania law, bad faith occurs when the insurer frivolously or for some unfounded reason refuses to pay proceeds of an insurance policy, and such conduct imports a dishonest purpose and means a breach of a known duty through some motive of self-interest or ill will. The court also said that the essence of a bad faith claim is the unreasonable and intentional (or reckless) denial of insurance benefits. [xi] In another federal court action alleging breach of an insurance policy, the court consulted Illinois law, and then stated that an EPLI carrier may not justifiably refuse to defend an action against its insured unless it is clear from the face of the underlying complaint that the allegations set forth fail to state facts that bring the case within or potentially within the insured’s policy coverage. [xii]

The federal court in the case in Rite Aid Corporation v. Liberty Mutual Fire Ins. Co., et al., 414 F.Supp.2d 508 (M.D. Pa. 2006) was called upon to determine if the carrier breached the contract and engaged in bad faith in accordance with the laws of Pennsylvania. Rite Aid was insured by policies issued by Liberty Mutual and Zurich American Insurance Company, and initiated litigation to recover approximately $1.6 million incurred in defending itself in an arbitration proceeding brought by a former executive officer, Beth Kaplan. In the underlying action, Kaplan alleged that Rite Aid fraudulently induced her to accept employment, and claimed that her association with Rite Aid hurt her ability to secure employment commensurate with her experience elsewhere. [xiii] The arbitration panel issued a ruling awarding Kaplan almost $5,000,000 plus interest in damages, but found in favor of Rite Aid on Kaplan’s claims for pre-employment misrepresentations and injury to her reputation. [xiv] In the action involving Rite Aid and its insurers, the Court determined that the carrier had a duty to defend Rite Aid in the Kaplan arbitration under the contractual language of the policy, and that the carrier breached this duty by denying coverage. After evaluating applicable state law, however, the Court found no evidence that the insurer acted with bad faith. [xv]

Just one employment-related lawsuit can jeopardize an uninsured or underinsured employer’s financial wellbeing. No organization that employs individuals can afford to be without appropriate EPLI coverage. Uninsured employers should not be lulled into a false sense of security simply because they have not suffered an employment practices claim in the past. Employers who lack any EPLI coverage should research on various providers and determine which carrier and policy provides the best coverage. Insured employers should evaluate their policies to determine whether their current coverage provides sufficient and appropriate indemnity. This type of assessment will help lessen the possibility of an undesirable surprise if and when a loss occurs.