Here’s a neat little story out of the Massachusetts Lawyers Weekly today on a Massachusetts Appeals Court decision holding that the surety on a construction contract does not cover, under the construction bond it issued, punitive damages awarded for the bad faith conduct of a principal of the construction company covered under the bond. Although turning on the specific language of the bond and what losses it extended to, the ruling parallels the common issue arising under insurance policies of all types as to whether a policy’s coverage extends to punitive damage awards and, in fact, whether public policy even allows parties to insure punitive damages awards, an issue I discussed awhile back in some detail in this post here. The primary issue in those cases is twofold: first, whether the policy language extends coverage to punitive damage awards and then, second, whether allowing a party to insure against such an award provides the wrong marketplace incentives with regard to corporate conduct and should not be allowed as a result.

Those same two issues were in play in this surety bond case, with the Appeals Court first concluding that the language of the bond does not extend to the punitive damages award itself, and second, that expanding the language to cover such awards would risk undermining the entire surety bond system in the state. The court’s conclusion on this issue is summed up in this paragraph from the opinion:  

By its terms, then, the bond did not cover punitive damages, payment of which is payment for punishment, not for "labor, materials and equipment" [which is what the bond stated it covered]. See Gasior v. Massachusetts Gen. Hosp., 446 Mass. 645, 653 (2006) ("purpose of punitive damages has been described as punishment and deterrence rather than compensation of an injured party"); Kapp v. Arbella Mut. Ins. Co., 426 Mass. 683, 686 (1998). To conclude that the bond encompassed punitive damages would be to rewrite the agreement Travelers made with Peabody and to risk diluting through punitive awards to a few subcontractors and materialmen the "security to [all] subcontractors and materialmen on public works," LaBonte v. White Constr. Co., 363 Mass. 41, 45 (1973), that the bond is designed to afford. See New Hampshire Ins. Co. v. Gruhn, 99 Nev. 771, 773 (1983).

I can’t say I disagree with the court on either aspect of its reasoning. Standard rules of contract interpretation, properly applied, cannot support a finding that the relevant language of the bond extended coverage to punitive damage awards, and the policy reasons for not extending coverage in general to such awards is frequently compelling in insurance coverage cases, just as it was in this case.

The case itself is C & I Steel v. Travelers Casualty and Surety, and you can find the opinion itself here.

The consensus in the legal community, and I don’t think it is just because they are looking hopefully for a new flow of work, has for awhile now been that fund investment losses resulting from exposure to the subprime mortgage mess will eventually generate substantial ERISA related litigation. There are plenty of avenues for these cases, not the least of which is plans and their fiduciaries bringing suit against investment advisors or investment funds for losses suffered by the plans on the theory that the advisors and funds improperly exposed the plan to such losses. This article here, out of the Boston Globe, provides a good example of exactly this line of litigation, detailing extensive losses to pension plans from investing in what were supposed to be conservatively managed bond funds at State Street. Here’s the overview provided by the article: 

Institutional money manager State Street Corp. now faces three lawsuits over its management of bond funds that were touted for their conservative investment strategies, yet posted losses over the summer because of risky holdings tied to the subprime mortgage industry . . .The latest lawsuit was filed last week in federal court in Boston by Nashua Corp., a Nashua, N.H.-based maker of paper and imaging products, against State Street’s investment arm, State Street Global Advisors. . . Nashua lost $5.6 million by investing company pension funds in State Street’s Bond Market Fund, due to the fund’s ’overexposure in mortgage-related securities,’ according to the lawsuit. Nashua’s complaint seeks class-action certification, which could allow other companies that invested in certain State Street funds to join the case.

Perhaps of even more interest on this front is the complaint that was filed a few weeks ago in the Southern District of New York by Unisystems, Inc. Employees Profit Sharing Plan, an ERISA governed plan, alleging substantial breaches of fiduciary duties under ERISA by State Street related to the bond funds it managed that the Unisystems plan and other plans invested in. The complaint seeks to be certified as a class action, and was brought by the Keller Rohrback firm, which looks to be on its way to becoming the Milberg Weiss (sans the indictments) of ERISA class action litigation. The complaint itself in that case, which you can find right here, is a terrifically detailed, step by step overview of the subprime mortgage problem, how it impacts ERISA governed plans, and the fiduciary exposures which that credit crisis has created – at least in theory so far – for investment managers and other ERISA plan fiduciaries. If nothing else, it gives you the whole story of this line of potential liability for ERISA fiduciaries.

And the scope of this area of liability and potential litigation involving ERISA plans is as big as you would expect. State Street notes that:

the problematic [State Street] funds [at issue in these lawsuits] amounted to a small fraction of the $244 billion in fixed-income funds it manages. About $36 billion of that total is actively managed — as opposed to passive funds that track indexes. The proportion exposed to subprime mortgages amounted to $7.8 billion as of June 30, and just $2.6 billion as of Sept. 30.

Well, you know what? That’s still billions of dollars of investments at issue, and that’s only involving one potential defendant in these cases. As the old saying in politics goes, a billion here, a billion there, and pretty soon you are talking about real money.

There’s an interesting, if brief, ERISA case out of the United States District Court for the District of Massachusetts decided last week that enforced a suicide exclusion in an employer provided supplemental life insurance program. The court found that the evidence in the administrative record supported the administrator’s determination that the employee had committed suicide within two years of electing the coverage, and that the benefits were therefore not available because the plan excluded death by suicide in the first two years of coverage. The case itself is not very noteworthy, other than to the parties themselves of course, except for one thing that jumped out at me. Many critics of the current legal regime under ERISA complain that the arbitrary and capricious standard of review that applies to cases, such as this one, where the administrator retains discretion to interpret and apply the plan, terribly distorts the outcome of cases in ways unfair to claimants. I have argued before that I am not convinced that, in the vast overwhelming majority of cases, this is true at all. Rather, most of the time, the same administrative record that would justify upholding a denial under the arbitrary and capricious standard on the theory that the administrator’s decision is reasonable given the evidence in the record, also contains enough evidence to prove the administrator correct under a de novo standard of review, where the court makes its own independent determination of the claimant’s entitlement to benefits. This case illustrates that point yet again: while the court upheld the ruling while applying the arbitrary and capricious standard, the evidence detailed in the opinion should have led to the exact same result even if the issue were considered de novo or the case treated as simply a breach of contract case under standard common law governing contracts. Indeed, in my other hat as an insurance coverage litigator, it seems clear to me that the result here, on the evidence detailed in the opinion, would have been the same even if this policy was not controlled by ERISA and was instead simply a private contract of insurance between the deceased and the insurance company; the policy language and the facts would have led to a finding of no coverage even if litigated as an insurance coverage, rather than an ERISA, case. The case is Keiffer v. Shaw Group, and you can find it here.

If, like me, you are fascinated not just by ERISA but by history and politics, this two part law review article, by James Wooten at the University at Buffalo Law School, on how ERISA preemption came to be, looks to be a must read. Here’s the abridged version of the story detailed in his articles: 

[The first of his two articles] recounts the key role of preemption issues in Congress’s decision to pass ERISA. Until shortly before ERISA’s enactment, employers and the AFL-CIO opposed comprehensive pension reform legislation. When states threatened to regulate private pension and welfare plans, however, the business community’s and the AFL-CIO’s strong desire for preemption all but forced them to support a federal pension reform law. Their support made passage of such legislation a virtual certainty. [The second of his two articles continues the story, explaining] how preemption issues led Congress to pass a broader pension reform law than it might otherwise have done. Business groups and the Nixon Administration hoped the congressional tax committees would limit the scope of federal regulation of pension plans. The congressional rules, however, gave jurisdiction over Congress’s power to preempt state employment laws to the labor committees. Their control over preemption allowed the labor committees to bargain for broader regulation than business groups and the Administration preferred.

Some twenty years or so ago, the historian Arthur Schlesinger published his book The Cycles of American History, on the idea that certain themes in American political life rise, fall, and then rise again over predictable periods of time. In much the same way, you can see, in the current rush by states to enact fair share and other health insurance reform laws, a rebirth of the same urge to regulate that, as Professor Wooten points out, gave rise to ERISA preemption in the first place, some thirty years ago.

You can download Professor Wooten’s articles detailing this history here (the first article) and here (the second).

In the first and so far last of our series of interviews with people of interest in the insurance and ERISA communities (I will do more at some point, but the interview post turns out to be the most difficult and time consuming to do well, which is probably why most people leave them to professional journalists turned bloggers like Peter Lattman at the WSJLaw blog, who do them really, really well), veteran insurance executive Robert Kingsley discussed the pace of consolidation in the insurance industry. Asked whether he saw that trend continuing, Robert noted that “there is little doubt the pace of consolidation will accelerate” and explained that in an industry, such as insurance, flush with capital, consolidation was inevitable. Robert had more to say on the subject, and you can find it here.

I am reminded of Robert’s comments by this story here in Massachusetts, that Spain’s largest insurer has now offered to pay $2.2 billion for comparatively small Massachusetts insurer Commerce, with the intention of using it as a platform to grow its business in the American market. Commerce was previously known primarily as a Massachusetts company focused on automobile insurance.

One of the interesting aspects about the news coverage of the Commerce acquisition is that the Spanish insurer, Mapfre, already operates in some 40 countries, but has a relatively small footprint in the United States and intends to use the purchase as a primary vehicle to expand its operations here. As Robert pointed out in the interview he did for this blog, insurers are making growth promises to investors that cannot be met by organic growth, which is driving the need to grow through acquisitions; that drive to grow appears to have played a large role in this purchase as well.

Here’s a tasty little tidbit for you insurance coverage junkies out there. Law.com has this interesting article on a ruling as to the number of deductibles that apply to suits alleging lung injuries from the flavoring used in manufacturing microwave popcorn. As the article explains, a New York state appeals court has found that the “supplier of the buttery substance used in microwave popcorn must pay a minimum $50,000 deductible for every worker at a Missouri plant who successfully asserts a claim that the flavoring caused lung problems or other respiratory ailments.” The issue before the court was whether certain policy language in the manufacturer’s insurance policies, which stated that the policies’ deductibles applied per occurrence, meant that one deductible applied to all such claims or instead one deductible applied to each such claim. As the article lays out the court’s reasoning, the court found that the structure of the policy language led naturally to the latter interpretation. Determining the number of claims or occurrences, including for purposes of determining how many deductibles apply, is a common problem in insurance coverage law, one that is oft litigated. The article’s presentation of the court’s reasoning suggests that the court approached this issue in an entirely appropriate manner, as it focused on the actual policy language used to reach its determination.

ERISA litigation, particularly in the area of retirement benefits, is one of those areas of the law that can be particularly complicated because both the governing body of law and the underlying fact pattern to which it is applied can be tremendously complex. Take, for instance, the example of disputes over whether the fiduciaries of a retirement plan erred in selecting investments for the fund. This example, as you have probably guessed, is not chosen at random, but instead because Susan Mangiero has this interesting post here on a particular equity investment strategy involving short selling, and on the question of whether such an investment strategy by a retirement fund would be prudent or instead a breach of fiduciary obligations. The strategy itself is relatively complicated, at least to anyone approaching it from outside the investment world, and so too is the question of how it compares to other investment tools the fund could have selected. Fortunately for those of us who litigate such questions, the rules of evidence allow those questions to be answered in court by the use of experts who actually know these points inside and out and can comment on them in depth. These underlying factual details are ones that must be considered in passing on whether a fiduciary breach has occurred before even getting to the question of how a particular investment strategy fits within the fiduciary obligations imposed by ERISA.

After mastering the details of the investment strategy at issue, one then still has to evaluate whether its use was a breach of fiduciary duty under the law of ERISA. I am quoted in Susan’s post on the fact that this in turn depends heavily not so much on whether the investment strategy itself was sound, but more on whether the approach taken by the fiduciaries to selecting that investment strategy was sound. As Susan discusses in her post, this in turn depends very much on whether the fiduciaries sought sufficient outside expertise on the particular type of investment strategy at issue to allow a third party looking in on the decision making after the fact – such as a judge or a jury – to say that the fiduciaries fully considered the merits of the particular type of investment in question before investing and thus did not breach their fiduciary obligations, even if the investment went south.

What struck me about this duty to investigate, for lack of a better phrasing, is that the obligations of the fiduciaries in this regard in many ways mimic the approach of the ERISA litigator handed a case after the fact involving the particular investment strategy and the question of whether its use was a breach of fiduciary duties: the ERISA litigator at that point brings in independent experts to advise on the appropriateness relative to the market of using that particular investment strategy, and bases a defense to a large extent on testimony from such experts that the investment strategy was sound. The fiduciaries themselves, however, could have effectively deflected claims of breach of fiduciary obligation in selecting the investment strategy in the first place by doing the same thing before ever making the investment; retaining outside experts to render this opinion prior to making the investment provides a strong defense against claims that the fiduciaries breached their obligations by making the investment. Indeed, contemporaneous reliance on outside, independent expertise to evaluate investment strategies is perhaps the best steps a retirement plan can make to head off potential claims of breach of fiduciary duty involving the selection of investments.

In this way, the question for fiduciaries and the plans they serve becomes as much as anything one of pay me now, or pay me later. They can avoid problems by paying for independent advice and investigation before making investments, or they can pay for the same advice later in defending themselves if they are sued. As a litigator, obviously, I am happy to retain experts and resolve the problem after the fact; as a counselor, though, I would always recommend the preemptive approach of obtaining such expertise before selecting a particular investment strategy.

Fiduciary status is the touchstone of the law of ERISA. From that status flows many of the obligations that ERISA can impose on a party, as well as extensive potential liability. For those of you wondering about who is a fiduciary and when for these purposes, Susan Mangiero has found a really fun (well, if you like this stuff, anyway) toy, the Department of Labor’s ERISA Fiduciary Advisor, an on-line tool for identifying whether or not someone has achieved fiduciary status for purposes of ERISA. Kind of like computer gaming for the ERISA set.

Michael Fox, who jots down his thoughts about employment law and other things over on his excellent blog, Jottings by an Employer’s Lawyer, raised an interesting point about electronic discovery in a post the other day when he was commenting on my recent discussion of whether electronic discovery threatens to render arbitration the better forum for resolving complex disputes. Michael pointed out that scalability is a key issue that should be considered when it comes to the appropriateness of ordering electronic discovery, and he raises the question of whether electronic discovery that is appropriate in a multimillion dollar case is equally appropriate in a case worth ten times less.

To ask the question is, in my book, to answer it, and I think that was Michael’s point as well. As the courts proceed to develop a body of jurisprudence governing electronic discovery, it seems clear that scalability is a factor that needs to be taken into account. It only makes sense, given the expense of electronic discovery, that as a case moves downrange in terms of the amount at issue, the obligation of a party seeking electronic discovery to actually document a need for such discovery (beyond basic and easily obtained emails and the like) and to evidence that such discovery is likely to be fruitful increase. I have talked before about my belief that the expense of this type of discovery requires that stricter showings of the need for such discovery be imposed than has traditionally been imposed on parties seeking discovery, and this is a natural concomitant of that idea. It is all part of the same thesis: that electronic discovery cannot be allowed to become the central focus and expense of litigation, must instead be treated as an adjunct to obtaining a just outcome, and as a result should be allowed only when and to the extent it is cost appropriate.

In yesterday’s post on Darren Abernethy’s paper on Fair Share statutes, I ended up riffing on the question of whether the Maryland legislature, by putting before the courts a particularly bad version of such a statute, had distorted the development of the law of ERISA preemption in a manner that would only hurt the cause of those who favor state health insurance mandates. I wondered whether the case law would develop differently if more balanced statutes, like the Massachusetts Health Care Reform Act, were analyzed by courts without the landscape of ERISA preemption having already been filled in by the decision holding the Maryland act to be preempted.

Critics of the Massachusetts act would likely argue that the Massachusetts version is so rife with problems that it is just as well if the legal environment, now that the Fourth Circuit has found the Maryland version of these types of laws to be preempted, is not too welcoming to such acts. That seems like a fair conclusion after reading law professor David Hyman’s piece on the “good, the bad and the ugly” in the Massachusetts statute, in which he pretty much takes the statute to task for being a poorly designed piece of state law. The Workplace Prof passed the article along, and you can find it here.

To the extent that the author’s analysis of the statute is right – that as economics and policy it just doesn’t work – it seems to support two points I have raised before on this blog concerning the Massachusetts act. First, that the questionable elements of the various acts enacted by the states suggest that federal preemption is a good thing, as a bulwark against what may be ill-conceived ideas by state governments when it comes to the topic of health insurance reform. And second, that the problem with these types of acts is that they play at the margins, and neither can nor do address the real cause of the problem of the uninsured, namely the incredible – and ever increasing – costs to employers of subsidizing health insurance in this country. This second point is one that appears to animate Professor Hyman’s piece, as he reflects on the fact that the Massachusetts statute has problems that stem from the particularly high cost of health care in Massachusetts relative to the rest of the country, as well as on the fact that the statute’s mandates are distorted by the high rate of health care inflation.