There is a growing trend in the US that first puts a relieved smile, but then a troubled frown on the faces of liability insurers.
It relates to class actions. Class actions? Smile?
Yes, because this type of action does not involve claims for actual property damage, personal injury or even economic loss suffered by the plaintiffs themselves, which means it is not usually covered by liability insurance.
Instead, this type of action focuses on a breach of consumers’ rights, e.g. where products are accused of failing to live up to accepted standards of safety, performance or advertising hype. No actual loss may have been suffered by the plaintiffs; but, the court may recognize their right not to be offered unacceptable products that could cause loss to innocent and unsuspecting ordinary people. Plaintiffs ask the court to award punitive damages (“punitive”, means “punishing”) to punish companies for putting profit before customers and to deter them from doing it again.
Examples from the real world
So why would insurers frown if such claims are not covered?
Well, these actions are becoming a major headache for many of our larger clients and the question is, does it fall to us to try and help them and if so, how?
Here are a few headlines from a US legal website that serve as examples of these class actions:
- Whole Foods Market Inc. was hit with a putative class action in the Illinois federal court, Monday, accusing the grocer of falsely marketing its St. John’s Wort supplement product as “standardized”, when testing reveals different bottles contain different amounts of the active ingredient.
- Fitbit Inc. asked a California federal judge, on Monday, to compel arbitration in a proposed class action accusing the company of making “wildly inaccurate” fitness trackers, arguing that the consumers have had a year for discovery and that the case must now go before an arbitrator.
- A Puerto Rico federal judge has put a hold on a false labeling suit over artificially colored cheese brought against Kraft Foods Group Inc., saying she is pausing the case until the U.S. Food and Drug Administration provides guidance on the use of the term "natural" on food products.
A European approach to this sort of class action may be that they are simply inappropriate. It is the task of governmental authorities, watchdog agencies and even the criminal courts to police such failings in products and advertising. We generally consider that the civil courts should not be filled up and slowed down by mass protestors who have not suffered actual damage, themselves.
But the American spirit appears to place great faith in the individual raising his voice and demanding financial punishment of wrongdoers, which is presumably seen as the best way to prevent cynical companies from continuing with such alleged abuses. In many countries, we try not to overburden the courts with cases.
Every society needs a court system for the rule of law; but, they are a large drain on public finances. However, some jurisdictions in the US are keen to find legal grounds to open the doors of their courts to all comers who have a grievance and who want their day in court.
Well, in US state courts, judges are elected to office by voters instead of being selected by any kind of ministry of justice. One way for a judge to please potential voters is to make plaintiff-friendly decisions and to be good at finding reasons why cases, with apparently weak connections to his state or city, should nonetheless be tried in his court.
Bringing in litigants from outside can be good for business, a sort of jurisdictional tourism, profitable for local hotels, shops and restaurants, owned and worked in by people who may be more inclined to vote for that judge. As it says on the Statue of Liberty, “Give me your tired, your poor, your huddled masses yearning to breathe free” and the emphasis is on access to justice, whoever you are and wherever you are from.
This mirrors the trend of US courts (especially in New York) deciding that they are competent to offer justice to aggrieved parties, from all around the world, where the connection to the US is tenuous or non-existent.
Defendant lawyers refer to these plaintiff-friendly courts as “judicial hellholes”; if a client corporation is sued in, for instance, Cook County or Madison County, which are both in Illinois, the defendant’s lawyer will work hard to get the case moved out of the area, to a court where the judges’ decisions are more likely to be determined by legal, rather than business, considerations.
California currently enjoys a reputation for class action law suits against food and drink companies. Local district attorneys and government agencies have teamed up with private contingency fee lawyers (“No win, no fee”) to bring new types of claims against manufacturers of paint and of prescription drugs. One such case, which resulted in a US$ 1.15 billion judgment, making three companies responsible for dealing with lead paint across the state, has been appealed.
Another case, seeking to blame drug makers for painkiller abuse, was recently dismissed by an Orange County trial judge, who recognized that dealing with such problems should fall to experts and policymakers at the Food & Drug Administration, not to local courts.
Duty to defend?
Should we help our insureds with this sort of case and if so how?
One way, could be to offer legal expenses coverage for such actions, covering the legal costs but not paying the damages awarded in the event that the plaintiffs are successful. In principle, any risk can be insured if the underwriter is able to understand the frequency and cost that the risk implies.
Indeed, in an ongoing case in California, the State court has taken a step towards forcing the duty to defend on insurance companies in a situation where the insurer does not admit that the duty arises. Duty to defend means that the liability carrier has to handle and fund the insured’s legal defence. This duty usually only arises where the damages claimed would be covered by the insurance.
In this case, a mattress manufacturer is facing a class action where the plaintiffs are claiming economic losses only, having decided against claiming damages for their alleged personal injuries. They are holding back from claiming compensation for personal injury as a tactical step to avoid the evidential difficulties this would entail for establishing a “class”.
The insurers have objected (and are appealing) arguing that the (economic only) losses claimed are not covered by the policy; if the plaintiffs had actually claimed damages for the illnesses claimed to have been suffered as a result of the allegedly defective mattresses, that would be different.
However, in California, there is legal precedent that establishes that the duty to defend is activated by the underlying facts alleged and not the monetary claims the plaintiff makes on the basis of those underlying facts. After all, the plaintiffs could choose to amend their pleadings and seek damages for personal injuries, even if that does not seem very likely in the current case.
We have ways of working out how much defence costs in legal proceedings may amount to; but, the levels of punitive damages, in these claims, are much harder to predict and therefore, setting adequate premiums is much harder. Jury awards can be as high as 10% of the defendant’s net worth (as shown by the company’s published accounts), although such awards are often brought down on appeal, where senior judges have the opportunity to impose reasonableness in the absence of a jury.
But in cases where actual loss or injury is suffered, punitive awards ten times the size of the compensatory awards can be upheld on appeal.
There is also the complication that punitive damages are awarded for situations where the defendant has been found to have wilfully, recklessly or knowingly sold dangerous products or lied about product safety. Do insurers want to insure such risks at all? Reinsurers are divided about whether this is workable or desirable and insurance companies cannot take this course, unless we have our reinsurers with us.
And even if we are prepared to insure punitives, some US states (such as Philadelphia) make it illegal to compensate punitive damages through insurance, quite logically, because the presence of insurance would reduce the punitive effect.
However, the overwhelming majority of all cases are resolved or settled before trial, as both sides are conscious of the risks of losing and the cost of litigation. Settlements which contain a punitive element are not usually broken down to show how much of the settlement is compensatory and how much is punitive, so the question can be avoided, in practice, if the settlement amount can be justified by reference to the risks of a high compensatory award.
The issue of what to do about class actions without actual loss will not go away. Especially in a soft insurance market, the major players will be watching each other closely, to see who dares offer a product to clients that could win business.
Hopefully, a solution will emerge before the dissatisfied corporations, of the US, rise up in a class action against all major insurers and accuse them of wilfully selling defective insurance products.