Continental Casualty Co. v. Board of Education

RODOWSKY, Judge. In this case the insurer and insured under a policy providing a form of directors’ and officers’ (D & 0) liability insurance dispute the extent of the insurer’s liability for counsel fees and expenses incurred by the insured in defense of a suit which alleged both covered and noncovered claims 4g&inst the insured. The parties also dispute the liability of the insurer for the counsel fees and expenses incurred by the insured in prosecuting the instant action. We shall hold that fees and expenses which are reasonably related to the defense of a covered claim may ordinarily be allocated wholly to that covered claim.

We shall also hold that the insurer is liable for the insured’s fees and expenses in this case. For a policy period of August 1, 1976, to August 1, 1979, Continental Casualty Company (CNA) issued to the Board of Education of Charles County, Maryland (the Board) a “Board of Education Liability Including School District Reimbursement Policy.” The policy was issued with an optional broad form of coverage under which “Assureds” were “[a]ll persons who were, now are or shall be employed by the School District____” In the insuring clause of the basic policy CNA agreed (a) With the Assureds that if, during the policy period any claim or claims are made against them ... for a Wrongful Act occurring during the policy period, the Insurer will pay on behalf of ... the Assureds ... for ⁵²¹ all loss [sic] which the said Assureds or any of them shall become legally obligated to pay; (b) With the School District that if, during the policy period, any claim or claims are made against the Assureds ... for a Wrongful Act occurring during the policy period, the Insurer will pay on behalf of ... the School District all loss for which the School District may be required or permitted by law to indemnify such Assureds. By the “Liberalization Endorsement” the insuring clause was amended to add subparagraph (c) which reads: “(c) With the School District that if during the policy period any claim or claims are made against it as a result of any Wrongful Act occurring during the policy period, the Insurer will pay on behalf of [sic] ... all loss which the School District shall become legally obligated to pay.” “Wrongful Act” is defined in the policy to mean any actual or alleged errors or misstatement or misleading statement or act or omission or neglect or breach of duty by the Assureds in the discharge of their duties, individually or collectively, or any matter claimed against them solely by reason of their being or having been Assureds during this policy period. By the “Liberalization Endorsement” to the basic policy, “Loss” was defined to “mean any amount which the Assured or School District are legally obligated to pay, including, but not limited to, any amounts which the School District may be required or permitted to pay as indemnity to an Assured, for a claim or claims made against an Assured for a Wrongful Act and shall include but not be limited to damages, judgments, settlements and costs, cost of investigation and defense of legal actions ... claims or proceedings and appeals therefrom, costs of attachment or similar bonds, provided always, however, such subject of loss shall not include fines imposed by the law, or matters ⁵²² which shall be deemed uninsurable under the law pursuant to which this policy shall be construed.” [ 1 ] The policy provisions relating to “Costs, Charges and Expenses,” as amended by the “Liberalization Endorsement,” read: “(a) The Assureds and/or the School District shall select and retain legal counsel to represent them in the defense and appeal of any claim, suit, action or proceeding covered under this policy, but no fees, costs or expenses shall be incurred or settlements made, without the Insurer’s consent, such consent not to be unreasonably withheld.” “(b) The Insurer may at its option and upon request, advance on behalf of an Assured, and/or the School District fees, costs and expenses which have been incurred in connection with claims made against an Assured, prior to disposition of such claims, provided always that, in the event it is finally established the Insurer has no liability hereunder, each agrees to repay to the Insurer, upon demand, all monies advanced on their behalf pursuant to this provision.” The Board’s policy from CNA provides for a $1,000 retention as to “[e]ach loss” and a limit of liability of $3,000,000 which is the “[m]aximum annual aggregate.” As a result of an exclusion also added by the “Liberalization Endorsement,” the policy does not cover any “Loss” resulting from breach of a construction contract. 2 Natural ⁵²³ ly, the litigation which spawned the subject case arose out of a construction contract.

On or about August 10, 1976, the Board entered into a contract with lorio Construction Co., Inc. (lorio) under which lorio was to build a new high school in La Plata, Maryland. By letter dated August 29, 1979, the Board, acting through the Superintendent of Schools, gave notice that it was terminating the contract. That letter “enclosed a copy of the Architect’s recommendation for termination ... on the basis that [the lorio] firm has failed to supply enough properly skilled workmen or proper materials to finish the project in a timely fashion.” lorio responded by letter of September 10, 1979, which in part reads: Your attempt at terminating our contract is absurd when viewed in the light of the incontrovertible fact that all of our work is virtually complete. The project has been occupied for months and has been in use by faculty, supervisory personnel and students.

Your refusal to formally take occupancy of the project despite the fact that it has been operational and used for many, many months is unconscionable. Such tactics can only be explained by your expressed desire to withhold, for no cogent reason, our long overdue contract balance. In October 1979 lorio filed suit against the Board and others in the United States District Court for the District of Maryland. 3 Iorio’s claims sounded both in contract and in tort. Among the Board’s codefendants were certain governmental entities, the partnership of the project’s archi ⁵²⁴ tects, two individual architects from that firm, and three Assureds under the CNA policy, M. William Runyon (Runyon), the Assistant Superintendent of Business and Supporting Services for the Board, Jesse L. Starkey (Starkey), Superintendent of Schools for the Board, and Joseph J. Lavorgna (Lavorgna), Director of School Facilities for the Board.

The Board, in December 1979, asked CNA to acknowledge coverage of the claims asserted by lorio against the Board and its employees. CNA in early 1980 denied coverage. On March 6, 1981, the Board, Runyon, Starkey, and Lavorgna sued CNA in the United States District Court for the District of Maryland for a declaratory judgment (the Declaratory Judgment Action). The plaintiffs sought a judicial determination that CNA was obligated for their expenses, including attorneys’ fees, in defending Iorio’s suit against them and also in the Declaratory Judgment Action. 4 The Board settled the lorio suit in December 1982 so that the Declaratory Judgment Action has become a suit for damages and fees.

There is no suggestion in the record that CNA has ever approved, or, after CNA took the position that there was no coverage, that CNA has been asked to approve, the defense conducted to the lorio suit, the fees incurred by the Board or the settlement. In the course of proceedings in the Declaratory Judgment Action the federal court has concluded that certain claims in the lorio suit were within the coverage of the CNA policy while other claims were not. Based on that preliminary legal ruling the Board has argued to the federal court that CNA was obligated to pay all of the legal fees and other ex ⁵²⁵ penses incurred by the Board in the lorio suit while CNA has contended that an apportionment of those costs between covered and noncovered claims was required. At that point the federal court invoked the Maryland Uniform Certification of Questions of Law Act, Md.Code (1974, 1984 Repl.Vol.), §§ 12-601 to -609 of the Courts and Judicial Proceedings Article.

The federal court has certified five questions to us, four of which deal with apportionment of litigation expenses between covered and noncovered claims. We shall state the precise questions and our answers to them in the course of analyzing the contentions of insurer and insured. Review of the lorio complaint is essential to an understanding of the issues raised in the litigation underlying the Declaratory Judgment Action. lorio chose to divide its complaint into seven counts. The second and each succeeding count incorporate certain introductory allegations and all of the allegations of preceding counts.

Counts I through III claim only against the Board and other governmental entities, but not against any individuals. Count I alleges breach of the express construction contract and claims the difference between the contract price as “adjusted and fixed by the defendants” and the amount paid to lorio. The difference is alleged to be $406,793. The second count seeks $298,313, allegedly representing the reasonable value of extras requested by the Board.

Count III claims damages of $1,488,744, allegedly caused by delay attributable to the defendants. This count specifies sixteen aspects of the project as to which lorio says it was impeded. These aspects range from an allegation that “the contract plans and specifications furnished required redesign” to an allegation that the defendants “interfered with local authorities in their inspection function to delay issuance of the temporary and permanent certificates of occupancy.” Count IV claimed only against the architects. Count V was interpreted by the federal court to rest on quantum meruit.

That count was apparently intended to be an alternative ⁵²⁶ to counts I, II, and III. It claims the total of the amounts sought in each of those three counts. 5 In the sixth count lorio sued only individuals. The contractor alleged that the defendant architects and officials of the Board had entered into a "corrupt agreement for the purpose of defrauding and injuring lorio and in pursuance of their common scheme and conspiracy, caused and performed the acts complained of hereinabove.” The ad damnum of count YI was $1,488,774. 6 Because this is precisely the amount of the ad damnum in count III, it is fair to interpret the "acts complained of hereinabove” as referring to the acts of hindrance specified in count III. Thus, tortious acts of Assureds allegedly occurred at each stage ⁵²⁷ of the project from design to occupancy.

Count VII of the complaint sounds in tort against all defendants and seeks damages measured by the loss allegedly caused to lorio through diminished bonding capacity resulting from the conduct of the defendants with respect to the project. 7 The federal court’s interlocutory legal ruling is that CNA’s policy afforded coverage with respect to counts VI and VII of lorio’s complaint. In count VI a claim is made against Assureds for a “Wrongful Act,” and in count VII a claim is made against the Board and Assureds for a “Wrongful Act.” The Board engaged counsel to defend and we infer that the Board is in effect indemnifying its three officials with respect to the costs of defense. The Board has become legally obligated to pay counsel and the litigation expenses. Those fees and costs allocable to counts VI and VII are a “Loss,” as defined.

CNA has promised to pay that “Loss.” It has not. Thus we have a case of breach of contract by CNA. 8 The interrelated questions certified to us in effect ask what principles determine the proof of damages where the defense is to a suit making claims of “Wrongful Acts” and also making claims that are not of “Wrongful Acts.” The Board contends that CNA in effect breached an agreement to defend the entire lorio suit so that the damages are measured by the cost of defending the entire suit. ⁵²⁸ The Board’s argument is an effort to bring this case under the rule of Brohawn v. Transamerica Ins. Co., 276 Md. 396 , 347 A.2d 842 (1975). That rule does not apply here.

Brohawn involved a homeowner’s policy which included “Comprehensive Personal Liability” coverage. There the insurer promised “[t]o pay on behalf of the Insured all sums which the Insured shall become legally obligated to pay as damages because of bodily injury or property damage, and the Company shall defend any suit against the Insured alleging such bodily injury or property damage and seeking damages which are payable under the terms of this Section, even if any of the allegations of the suit are groundless____” [Id. at 400, 347 A.2d at 846 (italics in original).] The suit arose out of an altercation with the plaintiff who alleged, alternatively, that the insured’s harm-causing conduct was either an act of negligence or an assault. Negligence was covered by the policy but assault was excluded. Coverage, as it related to the insurer’s obligation to pay damages, would not be determined until the jury characterized the facts as assault or negligence or neither.

With respect to the duty to defend, however, we said: Although the type of policy here considered is most often referred to as liability insurance, it is “litigation insurance” as well, protecting the insured from the expense of defending suits brought against him____ By clear and unequivocal language, [the insurer] has assumed the obligation of relieving its insured of the expense of defending an action alleging and seeking damages within the policy coverage. [Id. at 409-10, 347 A.2d at 851 .] In order to give effect to the duty to defend where the allegations, even if groundless, present claims both within and without the policy coverage the rule in Maryland is that “the insurer still must defend if there is a potentiality that the claim could be covered by the policy.” Id. at 408 , 347 A.2d at 850 (italics in original). ⁵²⁹ In the case now before us the Board in effect equates Iorio’s counts VI and VII with the negligence claim in Brohawn . Had Iorio’s complaint gone to trial and a verdict and judgment been rendered based on count VI there would have been coverage (as to damages) under CNA’s policy. Consequently, says the Board, that potentiality of coverage required CNA to defend the entire lorio suit. CNA on the other hand emphasizes that the subject policy is not a conventional liability policy.

There is no “duty to defend” language; there is no reference to defense of groundless claims, and there is no conferral on the insurer of the right to select counsel and control the litigation. The Board counters by underscoring CNA’s promise to pay fees and expenses in defending covered claims which the Board says is the substantial equivalent of a duty to defend. The subject policy is a variation on a type of liability coverage initially offered to protect corporate directors and officers and now known as D & 0. A form of D & 0 coverage is said to have been available through underwriters at Lloyd’s since the 1940’s, with the market for it having expanded rapidly in the mid-1960’s.

See Note, Liability Insurance for Corporate Executives, 80 Harv.L.Rev. 648 (1967). Policy forms have evolved and American companies have entered the field. As to D & 0 insurance generally, see J. Bishop, The Law of Corporate Officers and Directors: Indemnification and Insurance (1982 & 1984 Cum.Supp.) (ch. 8: “Directors’ and Officers’ Liability Insurance”); W. Knepper, Liability of Corporate Officers and Directors (3d ed. 1978) (ch. 20: “Liability Insurance”) (Knepper); Hinsey, The New Lloyd’s Policy Form for Directors and Officers Liability Insurance—An Analysis, 33 Bus.Law. 1961 (1978); and Johnston, Corporate Indemnification and Liability Insurance for Officers and Directors, 33 Bus.Law. 1993 (1978). D & 0 coverage usually has two aspects.

First it is intended to protect a corporation from its liability, either imposed by law or by a valid provision of the charter or ⁵³⁰ by-laws, to indemnify officers and directors, including indemnification for legal fees and expenses in litigation. Such policies are also generally designed to protect officers, directors, and other covered corporate employees both from liability to third persons and as to litigation fees and expenses when claims are made that they have committed a covered wrongful act as an officer, director, or employee. In the instant case the insuring clause in CNA’s basic policy, without the “Liberalization Endorsement,” was structured in this manner. Knepper, II 20.06, at 628, advises that “[a] program of D & 0 insurance for school district board members and employees is also written____ Premiums are based on the number of students, number of board members, and litigation history of the school district.” At 628 n. 45 Knepper supports the statement by citation to a newspaper article appearing in 1972, entitled “ ‘CNA Announces Entry in Growing D & 0 Field.’ ” Knepper, ¶ 20.16, also describes the defense of actions under D & O policies: It has been noted that “costs, charges and expenses” includes attorneys’ fees and other defense costs.

Thus the insurer should be consulted when counsel are retained to defend threatened or pending litigation. Under D & 0 policies the insured must provide its defense, although the insurer may participate at its option and may have a voice in selection of defense counsel. [Footnote omitted.] Provisions of the subject CNA policy relating to defense are substantially different from the duty to defend clause of a conventional liability policy. Assureds and/or the Board, not CNA, select and retain defense counsel. “Loss,” whether incurred by way of judgment, settlement, or defense costs, is charged against the policy limit without distinguishing between damages and legal fees. CNA has the option, but not the obligation, to advance expenses.

CNA’s consent, which is not unreasonably to be withheld, is to be obtained before expenses are incurred or settlements ⁵³¹ made. If CNA advances expenses under the subject policy and “it is finally established the Insurer has no liability” under the policy, then each recipient of advances agrees to repay CNA all monies advanced on his or her behalf. Here it has been established that counts VI and VII of lorio’s complaint asserted “Wrongful Acts” so that there is liability of CNA for the cost of defense attributable to those counts. That is not the same as a breach of the contractual duty to defend the entire suit under a policy and under a state of facts like those presented in Brohawn .

Consequently, the damages here are not measured, as a matter of law, by the reasonable cost of defending the entire lorio suit. That brings us to the problem of apportionment and to the certified questions. Question 1 is: Should the costs and expenses, including attorneys’ fees, incurred by an insured under a policy of insurance, such as was written in this case, be apportioned between those counts of the suit against the insured for which there is insurance coverage and those counts for which there is no insurance