Church’s Child Abuse Incident not Covered Due to Policy’s Abuse and Molestation Exclusion

In World Harvest Church v. Grange Mutual Casualty Co., 2016-Ohio-2913, 2016 Ohio LEXIS 1306 (May 12, 2016), the Ohio Supreme Court held that an abuse and molestation exclusion in a commercial liability insurance policy barred coverage for a 2006 incident where a two-and-a-half-year-old child was beaten in World Harvest Church’s (“World Harvest”) daycare center. The church had previously settled the underlying lawsuit with the child’s parents for $3.1 million and then sought reimbursement for that amount, which included attorney fees, under its commercial liability policy issued by Grange.

In the underlying matter, Michael and Lacey Faieta filed a lawsuit against World Harvest, its school and an employee named Richard Vaughan. The lawsuit alleged that the Faietas had dropped their son off for daycare one morning and when Mr. Faieta picked up him up that evening, the boy had bright red marks and abrasions on his rear end, back and upper thighs. When asked about the injuries, the boy stated that Vaughan, who had apparently taken over the classroom at some point during the day when the regular teacher left, had beaten him with a “knife,” which was later determined to be a ruler. His parents took him to a local hospital for treatment and then contacted World Harvest to report the injuries and seek action against Vaughan. Instead of investigating their claims however, World Harvest banned them from the school and church premises.

The Faieta’s complaint contained allegations against Vaughan for assault and battery and against Vaughan and World Harvest for negligence and intentional infliction of emotional distress. They also accused World Harvest of negligent hiring and supervision and additionally sought damages against World Harvest for Vaughan’s actions based on the doctrine of respondeat superior. World Harvest tendered the claim to Grange seeking a defense and indemnification and Grange agreed to defend under a reservation of rights and retained a law firm to do so.

A jury eventually awarded the Faietas $764,235 in compensatory damages and $5 million in punitive damages plus attorney fees from World Harvest and also awarded them $134,865 in compensatory damages against Vaughan and $100,000 in punitive damages. After reductions based on Ohio’s tort reform statute, the final judgment held World Harvest solely liable for $2.79 million, and Vaughan primarily liable for $82,365 for intentional infliction of emotional distress, with World Harvest being held secondarily liable for that part of the judgment. Prior to appeal, World Harvest settled the case with the Faietas for about $3.1 million.

Based on its reservation of rights, Grange denied claim after the verdict and in 2009, World Harvest sued Grange seeking reimbursement of the bulk of the $3.1 million it paid to settle the case. Grange argued that it was only obligated to provide coverage for “bodily injury” damages caused by an “occurrence,” defined in the policy as an “accident,” because it claimed that the policy excluded bodily injury that was “expected or intended from the standpoint of the insured.” It should be noted that while the policy contained a corporal punishment endorsement that provided coverage for injuries resulting from corporal punishment administered to a student by or at the direction of the insured, the policy also included an “Abuse and Molestation Exclusion” that denied coverage for bodily injury arising from “the actual or threatened abuse by anyone of any person while in the care, custody or control of the insured.”

The trial court granted summary judgment in World Harvest’s favor, holding that Grange was obligated to indemnify the church for $1.47 million in compensatory damages, attorney fees and postjudgment interest, but not the punitive damages. Both parties appealed that decision to the Tenth District Court of Appeals, which affirmed the trial court’s decision finding that Grange was obligated to reimburse World Harvest for the $82,365 in compensatory damages against Vaughan for which it was held secondarily liable, $693,861 in attorney fees, and $229,716 in postjudgment interest. However, it reversed that portion of the order directing Grange to reimburse the remainder of the damages award.

While both sides sought review from the Ohio Supreme Court, it granted review only to Grange, which contended that the abuse exclusion barred coverage for damages caused by Vaughan’s physical abuse of the child regardless of whether the damage award was based on World Harvest’s direct or vicarious liability. World Harvest claimed that the policy exclusion only applied if it was directly liable for the damages. It also claimed that Vaughan’s actions simply constituted “excessive corporal punishment,” actions it claimed were covered under the policy, and furthermore, that the abuse exclusion only excluded coverage for sexual, not physical abuse.

The supreme court noted that an insurance policy exclusion “will be interpreted as applying only to that which is clearly intended to be excluded” and held that the language of the abuse and molestation exclusion in the Grange policy was broad and excluded both actual or threatened abuse or molestation by anyone, just as long as the victim was in the care, custody or control of World Harvest at the time. As such, the court determined that the exclusion’s broad language did not limit the exclusion’s application only to damages awarded as a result of World Harvest’s direct liability, notwithstanding its contention to the contrary. In fact, the court stated that to provide coverage, it would have to add language to the policy, something it refused to do. As such, the supreme court reversed the appeals court’s determination that Grange was obligated under the policy to reimburse World Harvest for damages awarded to the Faietas. The court further held that because it had determined Grange was not responsible to cover the damages, the company was also not obligated under the policy to pay the award of attorney fees or postjudgment interest.

Eighth Circuit holds Insurer not Estopped from Denying Coverage

In National Surety Corp. v. Dustex Corp., No. 15-2096, 2016 U.S. App. LEXIS 7757 (8th Cir. Apr. 29, 2016) the Eighth Circuit U.S. Court of Appeals recently affirmed the district court’s ruling in favor of National Surety Corporation (“NSC”), the insurer, which had determined that NSC had no duty to defend or indemnify Dustex Corporation, the insured, and that NSC had effectively notified Dustex of the fact that it was defending the case under a reservation of rights in both a declaratory judgment action and an arbitration case.
In 2006, Cedar Falls Utilities (“CFU”), also known as the Municipal Electric Utility of the City of Cedar Falls, Iowa, contracted with Miron Construction Co. Inc. for an environmental upgrade to one of its coal power plants. The project included construction of a “baghouse” to collect emissions from a coal-fired boiler and Miron contracted with Dustex to fabricate the baghouse equipment. In 2007, CFU refused to sign a certificate of substantial completion based on its concerns regarding the baghouse and although the parties attempted to informally resolve the dispute throughout 2007, 2008 and 2009, Miron filed an arbitration demand against CFU in August 2009, seeking $475,000 for money allegedly due on the contract and CFU counterclaimed, seeking $1.4 million from Miron for breach of contract.
CFU moved the arbitrator to compel Dustex to participate in the arbitration but before the arbitrator ruled on that motion, CFU also filed a declaratory judgment action in Iowa state court seeking the same relief. After Dustex was served with the state court case, its attorney notified Dustex’s insurance broker, who then notified an adjuster at Fireman’s Fund Insurance Co. NSC’s parent corporation, who soon after told Dustex’s attorney that if the arbitration involved only breach of contract claims, there may be no coverage under the policy, although Dustex’s attorney claimed that the arbitration may also raise issues affecting property rights and advertising injury. After first wavering about potential coverage, Fireman’s Fund eventually determined that Dustex was entitled to a defense under a reservation of rights, and that decision was communicated to Dustex’s attorney in a letter that was not entirely clear about whether Fireman’s Fund was defending Dustex in both the arbitration and the declaratory judgment action. Fireman’s Fund retained counsel who represented Dustex in the declaratory judgment action and after the state court ordered Dustex to participate in the arbitration action, the same attorney continued his representation in that forum. CFU filed three amended statements of claims in the arbitration action, claiming breach of contract, breach of warranty and professional negligence and Fireman’s Fund sent supplemental reservation of rights letters to Dustex after each of those amended statements of claim was filed. Two days after the ROR letter regarding the third amended statement of claim was sent, NSC filed a declaratory judgment action against both Dustex and Miron in federal court in the Northern District of Iowa seeking a declaration that it had no duty to defend or indemnify Dustex and Miron in the underlying arbitration action. Dustex defended in part by claiming that NSC was estopped from denying coverage because it failed to effectively notice Dustex that it was defending the arbitration action under a reservation of rights. (The arbitrator eventually awarded CFU $2.6 million in damages plus nearly $750,000 in fees and over $71,000 in arbitration costs).
As to the duty to defend, the district court granted NSC’s motion for summary judgment
because it concluded that the policy issued to Dustex did not require NSC to defend or indemnify Dustex in the underlying arbitration action and also denied Miron’s claim that it was be an additional insured under the policy as moot. However, the court determined that there were disputed questions of material fact regarding the estoppel claim that could not be decided on a motion for summary judgment.

 

As to the estoppel issue, the court ruled that there was no right to a jury trial on that issue and referred the matter to a magistrate judge to conduct an evidentiary hearing. After that hearing, the magistrate judge noted that since the court had already determined that the policy did not afford coverage, coverage could not be established by estoppel. He also noted: “I believe these various exchanges demonstrate that Dustex knew, or should have known, that NSC was defending in the arbitration action under a reservation of rights. Even if an adequate reservation of rights notice was not given, however, Dustex must still show ‘justifiable reliance and prejudice’ to establish its defense of estoppel. Because it took no action to clarify the perceived ambiguity regarding whether NSC was defending under a reservation of rights, Dustex cannot claim justifiable reliance.” As such, the magistrate judge found that NSC gave Dustex timely and adequate notice that it was defending the claims under a reservation of rights and recommended that the Court find in favor of NSC on the estoppel claim, which was then adopted by the court.
Dustex appealed, arguing both that the district court erred in applying Iowa law rather than Georgia law to the estoppel claim and in finding that Dustex failed to establish its affirmative defense of estoppel. The appeals court first determined that the district court did not err in applying Iowa law but even if it had, under either Georgia or Iowa law, Dustex knew or should have known that NSC was proceeding under a reservation of rights.
As to the estoppel claim itself, the court held that through the various communications with Dustex, Fireman’s Fund had effectively reserved its right to deny the coverage in both the state court declaratory judgment action and the arbitration and agreed with the magistrate judge’s opinion that it would defy logic for Dustex to believe that Fireman’s Fund only reserved its right to deny policy coverage in a declaratory judgment action where no damages were being sought and not in the arbitration matter where they were.

 

Despite having prevailed however, the lesson to be learned here is that insurers need to be especially diligent in the wording of their reservation of rights letters when there is more than one action or potential action against the insured and for which, the insured seeks coverage.