New Louisiana Regulation Creates Safe Harbor For Certain Equity-Based Compensatory Plans of Privately-Held Companies

alan.berteau@keanmiller.com (Alan J. Berteau) — Fri, 21 Nov 2008 13:02:51 GMT

Offers and sales of “securities” must be registered unless there is an applicable exemption from the federal and state securities laws. The most commonly known exemption is the private placement exemption set forth in Regulation D promulgated by the Securities and Exchange Commission under the Securities Act of 1933 (and corresponding private placement exemptions under applicable state “blue sky” laws).

Regulation D was primarily designed to facilitate capital raising transactions, as opposed to employee stock option or stock purchase plans. Many people are unaware that when an employer (or controlling Shareholder) sells stock to an employee (even at a discount, or even if to an executive), such a sale is subject to the securities laws and applicable federal and state exemptions from registration must be found.

Federal Rule 701

In 1988, the SEC adopted Rule 701 which exempts from registration securities issued pursuant to a written compensatory employee benefit plan or written contract by a nonreporting (i.e., privately held) company. An employee benefit plan includes any purchase, savings, option, bonus, stock appreciation, profit sharing, thrift, incentive, pension, or similar plan. The participants in the plan (or party to the contract) must be employees, directors, general partners, trustees (if a business trust), officers, consultants, or advisers.

The plan or the contract setting forth the arrangement must be in writing and a copy must be given to the employees. The exemption is available only to the securities offered or sold by the issuer, which means the employee must find another exemption for their resale.

Rule 701 contains a limitation on aggregate sales price or amount sold in any consecutive 12-month period based upon the greatest of $1 million, 15 percent of the company’s assets, and 15 percent of the outstanding securities of the class.

Rule 701 also contains a disclosure requirement. The disclosure requirements apply only if the aggregate sales price or amount of securities sold during any consecutive 12-month period exceed $5 million. Subject to that qualification, an issuer relying upon Rule 701 is required to provide to investors, a reasonable period of time prior to sale, (1) a copy of the plan or contract; (3) a copy of the summary plan description required by ERISA or, if the plan is not subject to ERISA, a summary of the material terms of the plans; (3) information concerning risks associated with the securities sold; and (4) financial statements required by Part F/S of Form 1-A as of a date no more than 180 days prior to sale. Providing financial statements would be difficult for some issuers since, even though the statements do not have to be audited unless the issuer otherwise has audited statements available, they must be prepared in accordance with GAAP. It should err on the side of caution and make the required disclosures if there is a possibility that sales will exceed the $5 million limitation.

State Law

Until recently, Louisiana did not exempt sales of stock by employers to employees unless the sale was effected pursuant to a special type of stock option plan or pursuant to a stock purchase plan qualified under the Internal Revenue Code of 1986 (as amended), as Louisiana did not automatically exempt all types of transactions exempt under Federal Rule 701. Thus, unless one of the narrow Louisiana exemptions applied, privately held companies which desired to sell stock to Louisiana employees were forced to try to find another exemption, absent which they were forced to either (a) register the transactions with the Louisiana Commissioner of Securities, or (b) as was more likely the case, simply not proceed with the proposed sale to employees. However, the Louisiana Office of Financial Institutions recently promulgated a rule which provides that any transaction exempt under Federal Rule 701 is now exempt under Louisiana law. Louisiana Administrative Code, Title 10, Part XIII, § 801. A copy of the Rule can be found at www.ofi.louisiana.gov. The promulgation of this new rule has the effect of broadening the exemptions available to privately held companies which desire to sell stock to Louisiana employees.

For example, the sale of stock pursuant to a stock purchase plan (regardless of whether qualified under the Internal Revenue Code) or other written compensatory agreement which meets the requirement of Federal Rule 701 will now be exempt under Louisiana law. In addition, although Louisiana law has long exempted the issuance of stock options (and the exercise of such options) if issued pursuant to a plan which limited participation to employees only, Louisiana law did not exempt stock plans if the plan allowed for the issuance of options to non-employees (e.g., non-employee directors). Federal Rule 701 contains no such limitation with respect to option plans which authorize the issuance of options to non-employees and thus the new Rule seems to provide more flexibility for stock option plans as well.

Privately held companies which desire to sell stock or other equity ownership to one or more Louisiana employees should consider the securities laws implications of doing so before effecting any offers or sales.

Specialty Lines Insurance Market to Get Tighter?

Fri, 21 Nov 2008 10:54:37 GMT

We are beginning to hear speculation, and some evidence, that the current financial crisis could spread beyond AIG and impact the insurance industry more broadly, including the specialty lines insurance segment. Along with the rest of the insurance industry, the specialty lines insurance market has been soft (highly competitive). The key questions (concerns) for our business are whether the financial crisis will have a broad and serious impact on the specialty insurance industry, and whether the impact will be significant...

European Collective Action Reform and the U.S Model: Compare and Contrast

dandodiary@gmail.com (Kevin LaCroix) — Fri, 21 Nov 2008 03:12:56 GMT

There no longer seems to be a question whether European countries will adopt some form of collective action procedures. The questions now are what form the collective action mechanisms will take and to what extent will the processes will adapt or reject features of the U.S. class action model.

A November 6, 2008 article by NYU law professors Samuel Issacharoff and Geoffrey Miller entitled "Will Aggregate Litigation Come to Europe?" (here) takes a look at these questions and examines whether current European reforms are, in light of the extent of the aversion to the U.S. model, "likely to be effective in realizing their stated aims."

The authors begin their analysis by noting that while class actions were long "decried as the perversity of rapacious Americans," class actions are now "the focus of significant reforms in many European countries and even at the level of the European Union." Indeed, a "consensus" has emerged that "aggregate litigation will soon be the norm" in Europe. But by the same token, there is also a consensus that the European model of aggregate litigation "will not replicate American class action litigation with its domination of entrepreneurial plaintiffs’ attorneys."

The European movement toward aggregate litigation models has advanced because of the "need to create ex post accountability mechanisms" and the create mechanisms for the "efficient resolution of numerous intertwined claims." Aggregate litigation also mobilizes "efforts to foster prevention through the prospect of civil litigation."

The authors note that the criticisms of the U.S. model in many ways correspond with concerns raised inside the U.S. But the authors also ask whether or not the categorical aversion to the U.S. model may leave European reform efforts without the means to achieve desired results.

In order to assess whether the European rejection of the U.S. model sweeps too broadly, the authors examine the recurring criticisms of U.S. class action litigation. Among other things, the authors suggest that by framing the debate this way, the discussion will reflect both the weaknesses and the strengths of the U.S. approach and allow the reform process to benefit from the beneficial aspects of the U.S. approach.

The four criticisms of U.S. class action litigation on which the authors focus are:

(1) the danger that mass settlements may overgeneralize, by treating differently situated claimants as if they were similar, particularly where "an unsolicited and effectively unsupervised" agent resolves the case on behalf of absent class members;

(2) the most significant recovery is "often by successful class counsel, not by any class member;

(3) the uneasy relation between entrepreneurialism and avarice (as evidenced most recently by the criminal pleas of leading plaintiff securities attorneys); and

(4) the manipulation of the judicial forum for litigation gain (particularly through serial exploitation of "judicial hellholes").

The authors observe that what unifies these four controversies is "the role of private entrepreneurial lawyers" – which, the authors note, is "precisely what troubles Europeans about American class action practice." Nevertheless, motivated lawyer action is the "engine that fuels American aggregate practice." The authors ask whether the comprehensive rejection of the U.S. model "throws the baby out with the bath water" and whether "the controversies that arise in a system build on self-interest can be mitigated without disabling the entire undertaking."

In order to examine these questions, the authors look at the common features of European collective action reform efforts. While the legal reforms represent a broad spectrum of initiatives, there are three common features: (1) the tendency to allow only organizations to represent consumers in class actions; (2) the interaction between rules on litigation funding and class action procedures; and (3) the preference for "opt-in" rather than "opt-out" systems.

The authors find that there are potentially significant limitations to each of these unifying features. The authors also note that the evolving European efforts attempt to realize the benefits of collective action, but are "limited in their conception of how these processes will be realized."

The threshold issue that current European reform efforts must address is who will "organize, fund and lead the collective efforts." Both the strength and weakness of the American collective approach has been the "willingness to entrust a great deal of social regulation to private initiative and common law forms of adjudication." The authors express their concern that the European "cultural revulsion" to "accepting the reality of legal enforcement as entrepreneurial activity may leave the reforms without the necessary agents of implementation."

Discussion

The excesses of the U.S. class action system are a familiar hobby horse for social critics, both in the U.S. and abroad. Nevertheless aggrieved parties continue to pursue relief and redress through class litigation -- and not just consumers whose interests critics contend are hijacked by self-interested lawyers, but also well-financed institutional investors that are fully informed about their interests and fully able to act independently.

While Europeans disdain the excesses of the U.S. model, there have been periodic outbursts over the past several years where the need for collective action mechanisms has been so obvious that the local legal systems had to respond. Among the various corporate scandals that came to light earlier this decade were several instances where large group of aggrieved European investors were adversely affected and collectively sought redress. The current credit crisis underscores these issues. The further European development of collective action mechanisms does, as the authors note, seem to be inevitable.

On the other hand, the limitations of the U.S. model have been painfully apparent lately. The criminal sentencing of the leading plaintiff securities attorneys certainly highlights the corrupting potential of class litigation where the agent controls or even selects the principal.

There is also recent evidence that aggrieved parties involved in U.S-based litigation increasingly may perceive their interests to be best served outside of class litigation. Significant securities class action opt-out actions, in which would-be class members proceed independently to maximize their recovery and even to reduce counsel fees (about which refer here), suggest deep concerns about the utility of class litigation.

The authors may be correct that class litigation is most effective if it is driven by motivated entrepreneurs who can drive the process and maximize class results. Nevertheless, the lessons of the recent past in the U.S. highlight clearly how important it is for strict controls over class counsel.

The recent lessons also suggest the need for some modesty in advocating the U.S. class counsel model to Europeans. Indeed, rather than expecting the success of the European reforms to depend on European’s willingness to adopt aspects of the U.S model (such as the involvement of entrepreneurial counsel), perhaps it will be the case that the improvement of the current flawed U.S. model will depend on the adoption in the U.S. of existing or yet-to-emerge European innovations that develop as part of current European reform efforts.

Hat tip to the Point of Law blog (here) for the link to the article.

The Increasing Trend to "Set Up" Carriers (and the Inability (or Unwillingness) of Courts to Do Much About It)

martin@mdjwlaw.com (Chris Martin) — Thu, 20 Nov 2008 16:09:31 GMT

Efforts by policyholder lawyers to "set up" a carrier to make a decision which will enable the lawyer to prosecute a bad faith claim are nothing new. The trend, however, seems to be increasing across the country as some policyholder lawyers resort to such tactics with more frequency than in prior years. Frustration among the insurance industry has also been growing as courts across the country fail to recognize a "set up" for what it is and, instead, find the facts giving rise to the set up simply create a "fact issue" that must be resolved by a jury at trial instead of by summary judgment. A federal court judge in Texas recently decided a bad faith summary judgment issue against a carrier who was "set up" illustrating how easily the "set up" can occur and the limits on a trial court to do much about it once the bad faith suit is filed.

Several days ago, a federal judge in Dallas held an auto carrier was entitled to summary judgment on a spouse’s extra-contractual claims related to UIM benefits, but denied summary judgment as to the insured driver’s extra-contractual claims related to UIM benefits. In Haralson v. State Farm Mutual Auto. Ins. Co., 2008 WL 4821326 (N.D. Tex. November 5, 2008), an insured driver sustained serious bodily injuries in an accident. His spouse and daughter were following behind in another car and witnessed the accident. After accepting the liable driver’s policy limits, the injured driver and his spouse (through counsel) filed separate claims for UIM benefits under their personal auto policy.

Subsequently, State Farm tendered its UIM policy limits (per person not per accident) payable to both the injured driver and his spouse. The next day, the insureds, through their attorney, rejected the check because it purported to settle both claims. Unable to resolve this dispute through negotiation, the insureds filed separate lawsuits which were later removed to federal court and consolidated. Later, the carrier tendered another check for policy limits payable only to the injured driver. This second check was also rejected.

The underlying UIM claim proceeded to trial on the issues of liability and damages. At the conclusion of the trial, State Farm moved for summary judgment on the insureds’ claims for breach of contract and violations of the Texas Insurance Code. The insureds argued State Farm breached the insurance contract and violated state law by failing to pay each of them $50,000 UIM policy limits in a timely manner. In response, State Farm argued the injured driver’s spouse is not entitled to recover on her contract and extra-contractual claims because she was paid in full within 60 days after the court established the amount of her bodily injury damages. Under Texas law, a “UIM insurer is under no contractual duty to pay benefits until the insured obtains a judgment establishing the liability of the underinsured status of the other motorist.” The trial court agreed and held the carrier was entitled to summary judgment on the spouse’s claims as she had been compensated. The court reached a different conclusion with respect to the claims for the injured driver.

Unlike the spouse’s claims for damages, the court noted the carrier never disputed the injured driver was legally entitled to recover his damages. The court then noted the carrier waited 10 months after the accident to issue a settlement draft to the injured driver and his attorney. Prior to that time, the spouse had been included on the settlement check. Denying summary judgment against the injured driver, the court concluded if the injured driver could convince a jury the carrier improperly conditioned payment of his UIM claim on the release of the spouse’s claim for bodily injury damages, the carrier may be liable for breach of contract and delay damages under the Texas Insurance Code.

This case provides a good lesson and predictor on a growing trend of artificially created opportunities to “set up” a carrier for bad faith claims even though the carrier attempts to pay a claim in a fair and timely fashion. In this case payment was issued within 30 days of the accident to both the injured driver and spouse. According to the court, if the carrier had issued payment only to the driver, then it could have avoided a potential EC claim for its delay in payment and alleged breach of contract. It appears the insured’s counsel manipulated the circumstances to set up the carrier in this instance. Once the bad faith suit was filed, the carrier found itself in the unfortunate position of having to defend itself for trying to pay the claim quickly, but still not in manner that gave the trial court the ability to completely exonerate it from all extra-contractual claims.

Glaxo Glosses Over Avandia Risks

angel@reyeslaw.com (Angel Reyes) — Thu, 20 Nov 2008 15:53:49 GMT

Big Pharma shows its true colors yet again. Despite numerous complaints from doctors about the risk of heart attacks from taking the diabetes drug, Avandia, the manufacturer, GlaxoSmithKline PLC, continued to sweep overwhelming evidence under the carpet. Even a prominent Duke University researcher couldn’t get answers to questions about the drug’s safety. In early 2007, the New England Journal of Medicine found that Avandia increased the risk of heart attacks by 43%. Finally, as a result of that study, the FDA called for a Black Box Warning (the strictest warning available) on Avandia’s label.

From 1999 to the 2007 black box warning, Glaxo upgraded Avandia’s label over a dozen times. Despite that fact, Avandia’s sales skyrocketed to an all-time high in 2006. Since most people don’t read disclaimers on labels, Avandia users remained ignorant of its life-threatening side effects. Apparently so did the doctors who prescribed the drug. In the U.S., we are programmed by drug commercials to believe that a number of life-threatening prescription drugs are safe. Further, doctors are held to an almost God-like standard by most patients. So if your omniscient healthcare provider prescribes a drug, it must be good for you, right? As with so many other so-called “safe” prescription drugs, in Avandia’s case, nothing could be further from the truth.

But wait, there is hope! David Blumenthal, a Harvard Medical School professor and Director of Massachusetts General Hospital’s Institute for Health Policy was a huge contributor to the Obama health plan. Rumor has it that Mr. Blumenthal is now being considered for the top position at the FDA. The Obama administration might just bring the FDA back to relevance.

For more information on Avandia, read the Wall Street Journal article below:

Doctors Claim Glaxo Dismissed Worries on Avandia
NOVEMBER 19, 2008
By ALICIA MUNDY
Drug Maker Tried to Make Physician at Maryland Hospital Stop Talking About Concerns; Company Defends Its Effort

HAGERSTOWN, Md. -- Last year, after news broke that the diabetes drug Avandia was linked to a high risk of heart attacks, reports that the drug's maker had tried to stifle safety questions from a prominent Duke University researcher years earlier provoked a furor.

Now it turns out that the Duke researcher wasn't alone in suggesting a tie to heart problems. A doctor from a small Maryland hospital linked Avandia to congestive heart failure in 2000, but the drug's maker, GlaxoSmithKline PLC, rejected her warning and tried to make her stop talking about it with other doctors and hospitals, according to documents and interviews. Glaxo defends its effort, which it says was an attempt to correct "inaccuracies." The head of the doctor's hospital says he ignored Glaxo's overture.

Internist Mary Money of Hagerstown, Md., said in an interview that she first noticed problems with Avandia shortly after it came on the market in the summer of 1999. When she and a colleague began to raise concerns, Dr. Money said, the company dismissed their concerns. The Food and Drug Administration was unresponsive, the doctors say.

The Senate and House in 2007 began looking at whether Glaxo suppressed information and threatened the Duke researcher, charges that Glaxo has denied. Now the Senate probe, led by Chuck Grassley of Iowa, is investigating whether Glaxo's efforts to defend Avandia's safety led to intimidation against other doctors who were suggesting possible links to cardiac dangers. Mr. Grassley, the ranking Republican on the Finance Committee, has demanded documents from Glaxo and is expected to release a detailed report on Avandia soon, according to staffers.

Earlier in 2007, a study in the New England Journal of Medicine reported that Avandia could raise the risk of heart attack by 43%. The FDA called for a black-box warning on the drug's label about the risk of congestive heart failure and heart attack.

Dr. Money talked recently about a patient who came to her in 1999 with congestive heart failure. "That fall, I had a woman patient with massive fluid overload and such shortness of breath that she had to sit up at night," she said.

The patient had begun taking Avandia two weeks earlier, and an echocardiogram showed high pressure in the arteries of the lungs. Dr. Money said she took the patient off the drug, and within a few days the symptoms almost disappeared.

In the next few months, Dr. Money and the head of the hospital's diabetes center, Stephen Lippman, found other patients who had similar symtoms.

Dr. Money alerted SmithKline Beecham, the name of the drug maker before a 2001 merger. The company met with her and Dr. Lippman at Washington County Hospital in Hagerstown in April 2000.

The two doctors presented data on 85 of their patients who had used Avandia, according to documents from the meeting. More than half of the patients had significant edema, or swelling, and about half of that group also had high pulmonary pressure and shortness of breath. Three had been hospitalized for congestive heart failure.

The meeting was a waste of time, Dr. Money said. "They came to tell us how wrong we were, not to listen," she said.

Meanwhile, a company consultant who called into the meeting from the University of Pennsylvania dismissed the Hagerstown doctors' echocardiograms as too poor to show anything useful.

"They suggested we were country bumpkins, and practically said, 'Don't worry your pretty heads. We have smarter people than you looking at this, and there's no problem,'" recalled Dr. Lippman, a physician who also holds a doctorate in molecular biology.

A GlaxoSmithKline spokeswoman, Mary Ann Rhyne, said Dr. Money's theories were "unsubstantiated" and she was misinterpreting journal articles to support her case.

The next month, two SmithKline executives wrote to the hospital's chief of staff, calling on him to stop Dr. Money from talking about her concerns to other hospital doctors.

"[W]e respectfully ask that your hospital not involve itself in the dissemination of information which has not been substantially verified, and that you take immediate steps to stop the dissemination of this unsubstantiated information to your medical staff," said the letter, signed by two SmithKline executives, which was viewed by The Wall Street Journal.

GlaxoSmithKline's Ms. Rhyne said the letter was justified. "When GSK learns about statements by physicians that are inconsistent with the scientific data on its medicines, it has the responsibility to do what it can to correct these inaccuracies," she said.

The hospital's then chief of staff, Salvatore DiMercurio, said he decided to ignore the letter after consulting the hospital's executive committee. "It came down to whom do you trust -- a doctor you know and have worked with, or the people who are threatening you?" Dr. DiMercurio said.

Dr. Money also contacted the FDA, but she received only a form letter in response. The FDA didn't respond to requests for comment.

Drs. Money and Lippman said they found themselves at an impasse after the company and the FDA failed to listen to their concerns. Meanwhile, Dr. Lippman took a job in California.

Dr. Money said she continued to discourage the use of Avandia when speaking to colleagues. But she didn't seek broader attention until last year, when she read about the Duke researcher, John Buse, and Glaxo's reponse when he raised questions about Avandia.

In testimony to the House in 2007, Dr. Buse said he was characterized as a "liar" and threatened with a lawsuit if SmithKline's stock dropped because of his statements about Avandia's possible dangers.

Glaxo upgraded the warnings on Avandia's label more than a dozen times between 1999 and the 2007 black box, the strongest level of warning. One change, in 2001, said the drug could lead to excessive edema, which in turn could lead to congestive heart failure.

The changes got relatively little notice, and Avandia reached peak world-wide sales in 2006 of $2.5 billion.

In May 2007, after the New England Journal of Medicine reported the high risk of heart attack linked to the drug, officials in the FDA's safety division recommended the drug be pulled from the market.

An outside advisory committee disagreed, but sales since then have plunged. In the first three quarters of this year, Avandia sales were $856.7 million, down 45% from a year earlier, according to the company.

The American Diabetes Association and its European counterpart told doctors last month not to use the drug, though it remains on the market.

In addition to the Senate probe over Avandia, GlaxoSmithKline has been under investigation by the Senate over the safety of its antidepressant Paxil. The Justice Department is also investigating the company over marketing issues, the company has said, and a grand jury in Boston has asked witnesses about Paxil's safety, according to the witnesses.

It isn't clear whether Avandia is also part of that investigation. The Justice Department declined to comment.

—-- Louise Radnofsky contributed to this article.

Write to Alicia Mundy at alicia.mundy@wsj.com

Another Significant Canadian Securities Law Development

dandodiary@gmail.com (Kevin LaCroix) — Thu, 20 Nov 2008 01:54:56 GMT

In a recent post (here), I raised concerns about the possibility of U.S.-domiciled companies becoming subject to securities litigation under the Ontario Securities Act. Now, a recent decision by an Ontario Superior Court judge interpreting the Act’s provisions suggests the possibility of litigants using a parallel Ontario proceeding to circumvent the PSLRA’s discovery stay.

The decision arose in connection with the prospective securities action that claimants seek to pursue in Ontario court against IMAX and certain of its directors and officers. Under the provisions of Bill 198, enacted in 2005 and codified in Section XXIII.1 of the Ontario Securities Act (which can be found here), a preliminary procedure is required to determine whether a liability action under the Act can proceed.

Section 138.8 (1) of the statute, a liability action cannot be commenced "without leave of court granted upon motion with notice to each defendant." The court is to grant leave only "where it is satisfied" that the action "is being brought in good faith" and there is a "possibility" the plaintiff will prevail at trial.

The procedure specified for this determination is that the plaintiff and each defendant are to serve affidavits "setting forth the material facts upon which each intends to rely." The affiant may be "examined" on the affidavit "in accordance with the rules of the court."

The issue addressed in the recent decision in the IMAX case is the breadth of the examination that is to take place in connection with this authorization proceeding. In addressing this question, Madame Justice Katherine van Rensberg issued a ruling that potentially could compel defendants to answer questions under oath about a broad range of issues, even issues the claimants have not initially raised. A November 18, 2008 Globe and Mail article regarding the decision can be found here.

Justice van Rensberg wrote that the Act itself "provides no guidance as to the interpretation of the threshold test and what type, quality and quantity of evidence the court is to consider." IMAX had urged her to restrict examination to publicly available information. However, she found that shareholders seeking leave to proceed under the Act have "special powers" generally not available otherwise and she held that anyone being examined must answer questions that have a "semblance of relevance" even if it "might also reveal some other potential issues or wrongdoing not currently contemplated by the statutory claim."

The "semblance of relevance" test Judge Van Rensberg used is the threshold used in connection with discovery, the procedures with respect to which ordinarily apply once a case is underway. In effect, the Judge’s ruling permits discovery in the precertification stage, before the case has even been authorized to proceed. As comments quoted in the article note, defense advocates had militated in favor of inclusion of the precertification procedure in the Act as a way to bar frivolous claims, but now it appears that procedure can be used to compel defendants "to disclose evidence relevant to the merits."

This development, if it stands, not only seems to authorize plaintiffs to use the procedure to conduct a fishing expedition, it also could be used as a way to aid a parallel proceeding filed in U.S. courts, by allowing shareholders to examine company officials, even as to matters not raised either case.

As Adam Savett points out on his Securities Litigation Watch blog (here), this procedure, pursued in parallel with a U.S. filed lawsuit, could permit claimants to use the Ontario procedure to circumvent the PSLRA’s stay of discovery. Savett points out that IMAX itself is not only subject to the Ontario action but also to a separate action under the U.S. securities laws in the Southern District of New York, in which a motion to dismiss is pending. Savett observes that the Ontario court’s IMAX ruling "raises the specter of cases being filed cooperatively in Canadian and U.S. courts, with discovery in the Canadian action possibly being allowed to be used in the U.S. action."

This possible PSLRA discovery stay end-around takes on even greater potential significance in combination with the possibility of U.S.-domiciled companies and their directors and officers getting hauled into securities litigation in the Ontario courts. As I noted in my prior post (here), discussing the Ontario securities lawsuit recently filed against AIG, the prospect for U.S. companies of securities litigation outside the U.S. is unattractive. But perhaps even more unwelcome is the possibility of litigants using a parallel Ontario case against a U.S. company as a way to try to get material to be used to support a separate U.S. proceeding against the company.

If the recent IMAX ruling stands, U.S. securities litigators might have to become a great deal more familiar with Ontario’s securities laws and procedures.

Special thanks to Mark Renzel for providing me a link to the Globe and Mail article.

More about the AIG Lawsuit: A couple of interesting items about the AIG lawsuit appeared after I wrote my recent post about the case.

First, in a Guest Column on the Securities Docket (here), Dimitri Lascaris of the Siskinds law firm provides interesting additional detail about the "substantive and procedural advantages" offered to aggrieved claimants under the Ontario Act, as well as the potential damages available. The Siskinds firm is lead counsel in the Ontario proceedings filed against both AIG and against IMAX.

Lascaris also wrote in his column that "for a long time, America has largely dictated the standards by which issuers are obliged to conduct themselves in a globalized capital market. Like much else that is coming to an end in today’s capital markets, that era may be over. "

Second, Law.com has a November 19, 2008 article (here) about the case against AIG filed in Ontario. Among other things the article quotes Lascaris as saying that the AIG action is the first use of the use of the liability provisions of the Ontario Securities Act against a non-Canadian company.

And Finally: I would like to thank all of the many Canadian readers who commented to me about the AIG case. Numerous readers provided me with helpful additional information about the Ontario Act and about securities litigation in Canada. In that respect, several readers added helpful and interesting comments to the blog post about the AIG case, and I commend those comments to everyone's attention.

The Longer Term Impact of the Last Several Weeks on Pension Plans

srosenberg@mc-ep.com (Stephen D. Rosenberg) — Wed, 19 Nov 2008 15:38:57 GMT

There’s an old saying that nothing focuses the mind like an execution date; all trial lawyers have heard judges rephrase it as nothing focuses the mind so much on settlement as an imminent trial date. I thought of this saying when I read this article, in which Susan Mangiero of Pension Governance, whose Cassandra like warnings that companies need to focus on improving quality and other aspects of retirement plans - including their handling of hard to value assets - predates the utter disaster that has befallen such plans in the past several weeks, discusses the fact that, having now fallen into the abyss, pension plans and fiduciaries must focus their efforts on how to respond to the market collapse, which may have a larger impact on the pension plans than the market collapse itself. If there was ever a metaphorical execution date for plan fiduciaries and administrators, it’s the upcoming and ongoing storm of litigation risks, government investigations and intervention, and need to respond to the market volatility by tightening up investment strategies. If it may be hard, in hindsight, to defend the kind of alleged problems in investment management that occurred in the past that are at the heart of the “stock drop” type suits that are being filed against 401(k) and pension plans, it will be doubly hard to defend any continuation of the same types of errors in future cases, given the extent to which the world has changed over the past several weeks, both in terms of the environment in which such cases will be litigated and the expectation that fiduciaries should have learned from past mistakes.

This morning's thoughts on regulation...

ccurrin@currinlawoffice.com (Callie Currin) — Wed, 19 Nov 2008 13:51:27 GMT

In a recent ( 11/18/08) column by Michael Skapinker in the Financial Times, he discusses the tension between executive management, who often have personal stakes in short term outcomes, and shareholders/employees/pensioners, the latter two in particular have longer term stakes in the financial well-being of the institution. The column is titled "Every fool knows it is a job for government." What struck me was the complete absence of any discussion of the interest of depositors, borrowers or other consumers of the services the institutions offer. Much of the discussion relates to financial institutions and it seems to be the assumption that consumers of most financial services can move from one institution to another pretty easily. Of course that ability to move from one provider to another is a basic tenet of the free market.

No other financial institution has as long-term commitments to their customers as insurers and life insurers in particular. It is often not economically rational to move between insurers: note all the replacement regulations designed to make this as clear as possible to consumers. This long-term relationship is obviously not news to anyone in the life insurance industry. But it it continues to shock me, as more and more people seem to take federal regulation of insurance as a given in the fairly near future, that the articles dealing with the direction of regulation do not make a distinction between the short-term relationships that many financial institutions have with their customers and the long term relationships that are important in life insurance and annuities.

It is likely that corporate governance will again be raised as an important component of the new financial services regulatory landscape. And corporate governance is important, but corporate boards have a duty to shareholders, and as Michael Skapinker points out in his column, shareholders are increasingly transitory and are likely to have short-term interests too. That is why for life insurers, regulation through the boardroom may not be as effective as it may be for other insititutions.

Insurance consumers will always be more difficult to protect because of the long time horizons and the nature of the guarantees involved. As we watch Insurers apply to become thrifts, the lines among financial institutions continue to become more and more blurred. The danger is that in the eyes of inexperienced insurance regulators, the lines between the consumers of financial services will also be blurred, and if insurance companies are not regulated in a way that safeguards their customers, not "just" their shareholders, employees and pensioners, insurance regulation will not be effective insurance regulation.

Commercial seller requirement in products liability claims

jodynathan@STAUFFERLAW.COM (Jody Nathan) — Tue, 18 Nov 2008 23:18:47 GMT

Commercial seller requirement in products liability claims

Oklahoma’s products liability law is based on Restatement of Torts (Second) §402A. One of the requirements is that the seller be engaged in the business of selling such a product. Liability is not imposed upon occasional sellers who where the sale is not part of a business. Thus, in order to impose §402A liability, the defendant must be a "seller . . . engaged in the business of selling" the allegedly dangerous product. In Spence v. Brown-Minneapolis Tank, Co., 2008 OK CIV APP 90, the court stated that if defendant is not a commercial "seller engaged in the business of selling" the allegedly dangerous product, summary judgment is proper. In this case, intra-company transfer of goods was not a sale, and the defendant was not in the business of selling the doohickies that caused the injury. Thus, summary judgment was proper.

An office does not a restaurant make

jodynathan@STAUFFERLAW.COM (Jody Nathan) — Tue, 18 Nov 2008 22:32:19 GMT

Vacant not a question of fact

Bob owned a restaurant. Bob closed the restaurant. But Bob kept his office in the restaurant open. The sprinklers malfunctioned and the restaurant was water damaged. Bob’s insurance claim was denied. The policy did not cover losses on vacant premises or from freezing pipes. Then it was determined that the sprinklers had been deliberately tampered with and the tampering caused the damages. The claim was denied again. The trial court said the building was vacant and tha tthe vandalism and water damage exclusions precluded coverage. Summary judgment to the insurance company was affirmed on appeal.

There was no dispute that the building was vacant on the date of the loss because it was not being used for customary operations on the date of the loss. Using a small part of the building did not make the building occupied. Further, it did not matter that there was no evidence that Bob tampered with the sprinklers. The vandalism exclusion applied. There was no bad faith in the investigation of the claim.

Saiz v. Charter Oak Fire Insurance Company;
http://ca10.washburnlaw.edu/cases/2008/11/07-1449.pdf

In Products Liability Cases, Let the Plaintiff Beware

angel@reyeslaw.com (Angel Reyes) — Tue, 18 Nov 2008 15:01:57 GMT

There’s a strong argument, if not outright war, over the latest restatement of liability for product design cases. This restatement basically absolves manufacturers from liability for defects unless plaintiffs can prove a reasonable alternative design. In years gone by, strict liability protected the consumer. Now the waters have been muddied with “risk-benefit tests” that balance the risk of injury against the benefit of the product. In other words, plaintiffs must prove that the product’s inherent risks outweighed the benefits. To add insult to injury, lengthy disclaimers from product manufacturers further add to the confusion.

If a product is advertised as safe, it should be safe, right? Consumers should not have to read a bunch of legalese to determine whether or not to purchase a product when its safety is implied. And if the product is defective, how can the consumer prove it could have been designed better? Consumers aren’t engineers. All they know is that if they’ve been seriously damaged by a product, they should receive justice in the form of compensation. A reaffirmation of strict liability on the part of the manufacturer is the only fair and just course of action in the courts.

Please read the article which ran in the November issue of Trial Magazine below:

Reaffirming strict liability for product design cases
Trial Magazine
November, 2008
Larry S. Stewart

The battle over §2(b) of the latest restatement—which gives manufacturers a free pass from liability unless plaintiffs prove a reasonable alternative design—is far from over. It’s time to return to the bedrock principles of strict liability in design defect cases.

Forty-three years ago, the American Law Institute (ALI) launched a revolution in products liability law when it introduced the Restatement (Second) of Torts §402A. Before this, courts had struggled to find a rationale for liability for products-related injuries. Many cases, brought under either negligence or warranty theories, failed due to lack of privity or evidence of what happened in the design and/or manufacture of the product, or because of notice and disclaimer defenses.

Section 402A provides that product sellers are strictly liable for injuries from unreasonably dangerous products even if a seller exercised all possible care in the preparation and sale of its product.1 The rule was so self-evident that it quickly became the law of the land.

Under §402A, product sellers are liable for harms caused by any product that is “in a defective condition unreasonably dangerous” to the consumer and that is “dangerous to an extent beyond that which would be contemplated by the ordinary consumer.”2 A knife, for example, is not unreasonably dangerous because it is capable of cutting—it would be quite useless if it wasn’t—but if the knife’s handle is made of a brittle material that breaks and injures the consumer, the seller would be liable. In the lexicon of products liability law, this became known as the consumer-expectation test.

But not long after its adoption, §402A’s principle of strict liability for product defects became muddled by proposals for a risk-benefit “test” that would evaluate product defects under a negligence-type analysis, balancing the risk of injury against the benefit of the product. In many respects, the risk-benefit test stood products liability law on its head. It took what was an affirmative defense under §402A for “unavoidably unsafe” products and made it the basis for a determination of liability. Products would be presumptively safe unless plaintiffs proved that their inherent risks outweighed their benefits.

The ensuing debate over the proper rule for evaluating liability for product defects has generated much confusion. Part of the confusion comes from the conceptual difference between strict liability and the negligence-based risk-benefit theory. Further confusion results from the fact that risk-benefit is used to describe both a test of defectiveness and an affirmative defense. Many courts do not seem to appreciate these differences or choose to ignore them, and the resulting decisions are conflicting, inconsistent, and irreconcilable.3

Today, products liability law is a hodgepodge of rules, especially in design defect cases, where courts apply standards ranging from the consumer-expectation test to the risk-benefit test, with various hybrid combinations in between. Adding to the confusion, 11 years ago, the ALI did an about-face when it published the Restatement (Third) of Torts: Products Liability. Under the new restatement, §402A and the consumer-expectation test would be abolished and replaced with a risk-benefit test in which one element—the existence of a reasonable alternative design—is elevated to an absolute requirement.

In unintended ways, the harsh proposals of the new restatement have brought light to bear on the abysmal state of the law. But courts have so far largely rejected the core provisions of the new restatement, and it is not too late to bring reason and fairness back to products liability law. Consumer lawyers have an opportunity to direct a new look at products liability law, one that can reaffirm the social policies that underlie §402A.

The assault on strict liability
Modern products liability law began with the adoption of the Restatement (Second) of Torts §402A in 1965.4 Section 402A was based on an elegantly simple rationale: In marketing products, sellers bear a special responsibility to consumers. Sellers implicitly represent that their products are safe and that the public has a right to expect that reputable sellers will stand behind their products.

The term “strict liability” is somewhat of a misnomer. Section 402A liability does not automatically follow from a product injury, as it does in the case of harm resulting from the keeping of dangerous animals or other abnormally dangerous activities. To hold a product seller strictly liable, the plaintiff has to prove both that the product was defective and that the defect caused the plaintiff’s harm.

Not all defects result in liability. The restatement recognizes that some products that cannot be made completely safe still have utility. For these unavoidably unsafe products, the restatement provides a defense to a seller who markets “an apparently useful and desirable product, [even though it is] attended with a known but apparently reasonable risk”—as long as the seller provides “proper directions and warning.”5

Sellers cannot, however, feign ignorance of risks. They have an obligation to test product designs for residual risks, are charged with knowledge of what such testing would reveal, and, where feasible, must adopt safer designs over warning of risk.

The theory that the defectiveness of a product could be determined on the basis of what an ordinary consumer would expect from the product did not meet with universal acceptance. Some scholars believed that, notwithstanding the implications for consumer recovery, defectiveness should be anchored in more traditional concepts, principally negligence.

This suggestion was first expressed as a risk-benefit test by Vanderbilt University Law School Dean John Wade in his 1973 article On the Nature of Strict Tort Liability for Products.6 Wade argued for nullification of strict liability for all types of product defects—both manufacturing and design—and a return to negligence principles. He proposed that liability for defective products be based only on the reasonableness of the marketing decision under a “reasonably prudent manufacturer” standard, taking into account several different factors.

By the 1980s, the academic strict liability debate became quite partisan, as corporate interests embraced the negligence-based risk-benefit theory. In courtrooms nationwide, corporate defendants modified Wade’s approach by dividing products liability cases into two categories: those involving manufacturing defects and those based on design defects.

For the former, defendants conceded §402A liability. For the latter, which constitute the bulk of products liability claims, they argued that §402A should be replaced by the negligence-based risk-benefit theory. This strategy was coordinated by the Washington, D.C.-based Product Liability Advisory Council (PLAC), a legal advocacy group for product manufacturers.7

Consumer advocates, including plaintiff lawyers, were largely missing in the debate, whether because of ignorance of the issues or an assumption that strict liability was so firmly established in the law that it did not need defending. The debate, which was initially a state-by-state affair, was refocused when ALI decided to write a new restatement of products liability law in 1991.

The risk-benefit test
In proposals that closely paralleled PLAC’s agenda, the Reporters for the new restatement divided products claims into manufacturing defects, design defects, and failure-to-warn cases. The Reporters stated that manufacturing defects should continue to be decided under a strict liability regime, but they proposed a radical new concept for design defect cases based on what they claimed was the majority rule in the United States.

According to the Reporters, most states had adopted the risk-benefit test for design defect cases and made one factor of that test—the availability of a reasonable alternative design—an absolute requisite for liability.8 Based on that claim, the Reporters proposed that §402A and its consumer-expectation test be abolished in favor of their version of the risk-benefit test, articulated in the new §2(b). A highly controversial six-year debate followed.

The controversy was further fueled by the Reporters’ prior association with PLAC and what some observers saw as a blatant tort “reform” agenda.9 While the Reporters argued that the consumer-expectation test was inadequate to measure design defects and that an independent standard was needed, their principal focus was on protecting defendants, not public policy. An unstated premise of their position was the idea that jurors could not be trusted to make such decisions. This generated even more criticism from the opponents of the proposed new restatement.

At the same time, the Reporters undermined their own criticism of the consumer-expectation test by conceding that it was a valid criterion for the risk-benefit test and by expressly retaining it for food products. They overlooked the fact that the fundamental purpose of strict liability is to relieve injured consumers of having to prove negligence and to place the cost of injuries on the manufacturers rather than consumers, who are ordinarily powerless to protect themselves.

Commentators and other academics quickly contradicted the Reporters’ scholarship, reasoning, and motivation. The resulting deliberations were some of the most contentious in ALI history, and the proposals passed by extremely close votes.10

Before the ink was dry, the new restatement was in trouble. To date, it has been largely rejected by the courts that have reviewed it. In fact, while the restatement was still only in draft form, the Georgia Supreme Court refused to require proof of an alternative design.11 And the supreme courts of California and Connecticut emphatically rejected §2(b).12

In a stunning decision, the Connecticut Supreme Court weighed in just days after final passage. In Potter v. Chicago Pneumatic Tool Co., the court boldly questioned the scholarship underlying §2(b) and concluded that the Reporters were wrong. The court, independently reviewing the law, found that “the majority of jurisdictions do not impose upon plaintiffs an absolute requirement to prove a feasible alternative design” and that such a requirement “imposes an undue burden on plaintiffs that might preclude otherwise valid claims from jury consideration.”13 The Potter court also rejected the new restatement’s position that the consumer-expectation test should not apply in design defect cases.

After Potter, the Maryland Court of Appeals and the supreme courts of Kansas, Missouri, New Hampshire, Oregon, and Wisconsin all refused to adopt §2(b).14 These decisions are remarkable because they bluntly state that the new restatement “goes beyond the law,” sets the bar too high, and would be a regression in the law that would roll back decades of individual justice and return the courts to an era of defendant protectionism.15

Indeed, if the new restatement were followed, a manufacturer would have no incentive to produce as safe a product as possible. It would only have to design a product to meet a standard whereby benefits outweighed risks. When sued for a defective design or a failure to warn, a manufacturer could take refuge in the opinions of compliant experts and the inherent difficulties plaintiffs would have in proving an alternative design.

Looking back, striving forward
The battle over the new restatement is far from over. Defense interests have not been deterred by their losses to date, and battlegrounds remain in the more than 40 states where no opinions on the new restatement have been issued by courts. Even though there is no need to further restrict products liability claims,16 every lawsuit is another potential vehicle for raising these repressive rules, and uninformed plaintiff lawyers can easily be blindsided.17

Consumer lawyers must learn how to defend against the new restatement and the reasonable-alternative-design trap. They must begin by understanding the history of strict liability and the companion history of the risk-benefit theory. This includes knowing the powerful reasoning of the decisions that have already rejected the new restatement.

The problem is not just that the tables are tipped in favor of defendants when plaintiffs must prove that a product’s risks are greater than its benefits and that an alternative safer design existed. Nor is it only that having to prove an alternative safer design in every case is contrary to the majority rule. As the Wisconsin Supreme Court forcefully stated, the new restatement also would create a form of previously unknown negligence whereby plaintiffs have to prove both that the sellers’ conduct was negligent and that there was an alternative design the seller could have adopted.18

The social policies underlying §402A are just as valid and relevant now as they were 43 years ago. In a time of rapidly changing technology, it is just as true today, if not more so, that sellers bear a special responsibility to consumers to provide safe products and that the public should have the right to expect that sellers will stand behind their products.

It is just as true today that sellers are in the best position to demonstrate that the benefits of a product outweigh its risks. And, it is just as true today that the burden of product injuries should be placed on those who market products, rather than on those who use them.

The time has come to redefine the issues in this battleground. Consumer attorneys need to question whether risk-benefit in any form should be a valid basis for determining if a product is defective.

All consumer lawyers should join in the debate in a systematic and organized way, at both the state and national levels, to argue for a return to the bedrock principles of strict liability. Risk-benefit as a test of product defect gained traction, in part, because plaintiff lawyers sat on the sidelines. We should not let that sad bit of history repeat itself.

When products are dangerous beyond the expectations of ordinary consumers, the seller should be liable for all resulting harm, regardless of whether it exercised all possible care. Consumer lawyers should not shy away from the consumer-expectation test. It is no more indefinite than negligence concepts, which are routinely applied in myriad complex cases like those arising from professional malpractice.

Nor are products too complex for consumers to understand. It is not necessary for a consumer to appreciate all the details or intricacies of a product to have an expectation of safety.19 With modern marketing and advertising, there are virtually no products for which consumers do not have an expectation of safety, especially with the use of family scenes in ads. Also, the absence of warnings and cautions in that advertising—or the impossibility of reading or hearing warnings—likewise makes it seem that products are safe for almost unlimited uses.

Moreover, plaintiff lawyers need to recognize that much of the opposition to the consumer-expectation test stems from the notion that the evaluation of product design or warning is too important to be left to juries of ordinary citizens. Society entrusts the most important decisions of life and death, as well as complex business disputes and professional judgments, to such juries. Clearly, they are capable of making decisions concerning product safety and the adequacy of product warnings.

Consumer lawyers need to stress that the only role for a risk-benefit analysis in strict liability should be as an affirmative defense—one that comes into play only when a seller has adequately tested its product and taken all reasonable steps to adopt a safe design.20 If a residual risk remains and users have been warned so that they can avoid harm, then—and only then—should a seller be allowed to defend on the grounds that the benefits of the product outweigh its risk. This allocation of proof is reasonable because, after all, it is the seller who is in the best position to defend its design choices and marketing decisions.

This battle is too important to let others frame the debate. Ultimately, it is over whether caveat emptor is going to again rule products liability law. That outcome will be prevented only if we make the case for reaffirming strict liability for products liability claims.
Larry S. Stewart, a former president of AAJ (then ATLA), practices law with Stewart Tilghman Fox & Bianchi in Miami.

Department of Labor Issues New Family and Medical Leave Act Regulations

alan.berteau@keanmiller.com (Alan J. Berteau) — Tue, 18 Nov 2008 13:22:41 GMT

by A. Edward Hardin, Jr.

The U.S. Department of Labor has released the new Family and Medical Leave Act regulations. The new regulations will become effective January 16, 2009. The DOL issued its proposed new regulations in February 2008.

The DOL received over 20,000 comments regarding the proposed regulations, and the new regulations are over 700 pages long. But with an effective date in January 2009, employers do not have long to learn the in’s and out’s of the new regulations. Stay tuned as we review the new regulations too.

Insurer Added as Third Party Under Insurance Act Permitted to Examine Insured for Discovery

Tue, 18 Nov 2008 04:54:44 GMT

Kapileshwar v. Sivarajah is an interesting decision of Master Ronald Dash. It deals with some of the problems that can arise where an auto insurer exercises the right conferred by s. 258(14) of the Insurance Act and has itself added as a statutory third party in an action against its insured. That right is given [...]

Kapileshwar v. Sivarajah is an interesting decision of Master Ronald Dash. It deals with some of the problems that can arise where an auto insurer exercises the right conferred by s. 258(14) of the Insurance Act and has itself added as a statutory third party in an action against its insured. That right is given to the insurer where it denies coverage under the contract of insurance.

In this case, the issue before Master Dash was whether the insurer (ING), having added itself as a third party in the action against its insured, had the right to examine the insured for discovery.

(The insured had not defended the action, which was one for personal injuries arising out of a motor vehicle accident, and had been noted in default. Once ING had been added as a statutory third party, it pleaded that the accident had been staged, that there had been no collision between vehicles and that the plaintiff was not injured.)

On this motion, the question was whether ING had a right to examine its insured.

Master Dash noted that for a right of examination to exist under Rule 31.03(3), the party sought to be examined must be adverse in interest to the proposed examining party. Could the requisite adversity ever exist between an insurer and its own insured? He held that it could (although rarely). However, we think that there was a better way to arrive at the same conclusion and we’ll get to that in a moment.

The Master reviewed the legislation and the caselaw decided under it. Citing Bortuzzo v. Barna, [1986] O.J. No. 2888, 54 O.R. (2d) 598 (S.C.O.) and a more recent New Brunswick decision, Parlee v. Pembridge Insurance Co. 2005 NBCA 49 (CanLII), [2005] N.B.J. No. 174, 253 D.L.R. (4th) 182 (N.B.C.A.), he concluded:

The insurer, in defending the plaintiff’s claim in its capacity as statutory third party, notwithstanding coverage issues between it and its insured, must defend against the plaintiffs’ claim in the same manner as if it had accepted coverage and put in a defence on behalf of its insured. In defending the plaintiff’s claims it cannot take a position contrary to the interests of its insured and in fact must act in the best interests of its insured.

The Master went on to observe that issues between the insurer and the insured are not to be decided in the plaintiff’s action against the insured, with one exception, a third party action under Rule 29:

The only time coverage issues may be raised in the original action brought by the plaintiff is if the defendant chooses to put in a defence and adds his insurer as an ordinary procedural third party under rule 29.01 in order to seek indemnity for the claims of the plaintiff. Then the issue would be decided in the third party action, which may or may not be tried with the main action.

This proposition makes sense. If an insured did not have the right to have the coverage issue determined in a third party action, an insured to whom coverage has been wrongfully denied by the insurer could end up with a judgment against him or her and only then have the right to sue for a determination of the coverage issue. Permitting the insured to bring a third party claim against the insurer sees to it that the liability of the insurer to the insured is determined at the same time as the liability of the insured to the plaintiff.

However, that’s not what some of the cases have said. For instance, it was held in Chapman v. Ghesquiere (1998), 39 O.R. (3d) 687 (Gen. Div.) that once an insurer has become a statutory third party under the Insurance Act, its insured cannot issue a third party claim against it. There, Justice Leitch followed the reasoning of Justice Cavarzan in Merrill v. Sommerville, (1992), 11 O.R. (3d) 444, [1993] I.L.R. 1-2902 (Gen. Div.), who said:

[R]ule 29.01 cannot operate to bring in an insurer as a full-fledged third party, where an insurer has already obtained the special, limited third party status conferred by s. 226 of the Insurance Act. This would not be a rule “supplementing” the Insurance Act provision; rather, it would be a rule nullifying it.

We don’t find this reasoning as persuasive as did Justice Leitch in Chapman. Although both s. 258(14) and Rule 29 speak about a “third party”, the two concepts are completely different. An insurer added under the Insurance Act might more aptly be described as an “intervenor”. Permitting an insured to sue the insurer on the coverage dispute in a third party claim is not at all inconsistent with the insurer defending the allegations against the insured in the main action. Prohibiting an insured from having the coverage issue litigated concurrently with the main action means that the insured might have a long wait between judgment being entered against him or her and having a determination of his or her right to indemnity from the insurer.

So, on the authorities, it appears that Master Dash’s endorsement of an insurer being both a third party under the Insurance Act and a R. 29 third party, is not supported. But we think it should be.

Back to the issue in this case: could ING examine its insured?

Master Dash concluded that, in exceptional circumstances, such as where the insured’s conduct prejudices the rights of the insurer, that insurer has a right to examine the insured. He gave as an example an Alberta case Thompson v. McCallum, where the insured had admitted in his statement of defence, that he had been driving the car in which the plaintiff had been a passenger. The insurer suspected that the insured had, in fact, been the driver. Master Dash said that these circumstances placed the insured in a position in which his interests conflicted with those of the insurer:

The defendant was by his actions prejudicing the right of the insurer to fully defend against the plaintiff’s claims. The insurer would have been the victim of collusion between the plaintiff and the insured. The insurer and insured in that rare scenario were adverse in interest and the insurer could examine the insured for discovery.

Applying the same rationale, the Master held that ING was entitled to examine its insured here.

We don’t find this reasoning very satisfying. For one thing, the Thompson approach endorsed by Master Dash gives to the insurer the opportunity to create a conflict of interest through its pleading. Just because the insurer has pleaded that the collision was staged and its own interests are therefore threatened, why should it be able to avoid the prohibition against taking a position adverse to that of its insured?

It seems to us that a stronger rationale for allowing the insurer a right of examination is available. In both Thompson and this case, the insurer suspected the insured of colluding with the plaintiff in a “sweetheart deal” to gain unmerited compensation for the plaintiff. Procedurally though, it would be to the advantage of the insured in each case if the insurer could show that the insured was lying: that would defeat the plaintiff’s claim against the insured. It seems to us that rather than focusing on the interests of the insurer (which should not be relevant), the better rationale for allowing the insurer to examine the insured is that the examination is aimed at eliciting evidence that will aid in the insured’s defence against the plaintiff’s claim. So, it isn’t really adverse to the insured’s interest.

Real Estate E&O Insurance

Tue, 18 Nov 2008 04:02:31 GMT

Real estate related classes of business account for a large share of all professional liability insurance business written, and that number is probably going up (or down?) as the credit crisis impacts both the number of survivors and professional liability insurance rating. A recent Rough Notes article (see here), prepared by MarketStance, claims that 64% of all E&O premium is real estate related. While that number sounds high, the definition of real estate used includes a wide range of classes...

C.A.’s Applies “Litigating Finger” Test to Add Defendants After Expiry of Limitation Period

Tue, 18 Nov 2008 02:33:16 GMT

In June, the Court of Appeal laid to rest a dispute that had persisted for more than four years: do courts still have the power to allow defendants to be added to actions after the expiry of the limitation period, on the basis of “special circumstances”? In a pair of rulings–Joseph v. Wonderland and Meady v. Greyhound–the Court held that for claims arising after January 1, 2004 (when the Limitations Act, 2002 came into force), the ”special circumstances” power no longer exists (at least for causes of action whose limitation period is now found in the new Act: see below…) Our discussion of those two cases can be found here.

On November 14, the Court of Appeal considered the Limitations Act, 2002 again in Spirito Estate v. Trillium Health Centre. However, the ruling made by Justices Rosenberg, Gillese and Blair was that, on the facts of this case, they did not have to interpret the Limitations Act, 2002.

The case was an appeal from a decision of Justice Katherine van Rensburg. She had granted a motion, brought by the plaintiffs in a medical malpractice action, to add two physicians as defendants after the expiry of the two-year limitation period under s. 38(3) of the Trustee Act.

(This limitation period, which applies to actions on behalf of a deceased person, has been preserved by section 19 of the Limitations Act, 2002. It runs from the date of death of the deceased. The Court of Appeal has previously held, and reaffirmed in Spirito, that the discoverability principle does not apply to actions governed by s. 38(3).)

In this case, the original statement of claim had named as defendants “Doctors AB, DC, EF, GH”. On the motion before van Rensburg J., the plaintiffs sought to substitute two named physicians for Drs. AB and DC, claiming that they had only been able to identify these doctors as a result of evidence obtained through the discovery process.

Key to the decision of Justice van Rensburg (and to that of the Court of Appeal) was that the original statement of claim had made very specific allegations that, as it turned out, were directly referable to the doctors whom the plaintiffs sought to add. She determined that naming these doctors as “AB” and “DC” in the original pleading had been a misnomer. In other words, the doctors had been sued within the Trustee Act limitation period but had been misnamed.

In coming to this conclusion, van Rensburg J. applied what is known as the “litigating finger” test for misnomer: “would a person having knowledge of the facts be aware of the true identity of a misnamed party by reading the Statement of Claim? If so, the defendant will be substituted unless there is prejudice that cannot be compensated for in costs or by an adjournment.”

The Court of Appeal agreed with van Rensburg J. It elected not to decide whether the transition provisions found in s. 24 of the Limitations Act, 2002 applied to a case in which the claim is brought after January 1, 2004 but the limitation period is one preserved by s. 19 of the Act (as was the case here). It left that issue to another day. However, it proceeded to consider this case under both possible scenarios: if the Limitations Act, 2002 applied and if it didn’t.

If the Act did not apply, this case did not have to be decided on the basis of limitation periods, transition provisions or “special circumstances”. The members of the panel agreed with van Rensburg J., that this was merely a case of misnomer. The action had been commenced within the Trustee Act limitation period, but the two doctors had been misnamed as “AB” and “CD”. Applying the “litigating finger” test, the statement of claim had pleaded facts that sufficiently identified the two doctors. As the Court observed, what the plaintiffs were really doing was not to add parties but to correctly name existing defendants. No allegation of prejudice had been raised by the defendant doctors, so the Court held that there was no reason to interefere with Justice van Rensburg’s decision.

If the Limitations Act, 2002 did apply, the situation was no different. The defence argued the defence that s. 21(2) of the Act imposed a narrower test than the old law of “misnomer”. (Subsection 21(2) says that subsection 21(1) (which prevents the addition of defendants after the expiry of the applicable limitation period) “does not prevent the correction of a misnaming or misdescription of a party”.)

The Court could see no basis for a distinction between “misnomer” and “misnaming”; hence, the same result should follow whether s. 21 applied or not.

(Actually, on the Court’s reasoning, if the case fell under the Limitations Act, 2002, s. 21 ought not to apply at all. That section deals with the addition of a defendant after the expiry of the applicable limitation period. But the Court of Appeal found that where a defendant has been sued but has been misnamed, the action is timely if the litigating finger test is met. Thus, to take this case for example, Drs. AB and CD were sued within two years of death, so the limitation period against them had not expired. The plaintiffs had only to correct the misnomer. Thus, s. 21 should have had no application.)

Finally, as David Cheifetz pointed out to us, the ruling leaves open another interesting question. As noted above, the Court did not decide whether the Act applies to suits brought after January 1, 2004 but for which the applicable limitation period is one preserved by s. 19. In addition to the Trustee Act, these include the one year limitation period foudn in statutory condition 14 of the Insurance Act and a number of others. The decision in Spirito leaves open the possibility that the law of “special circumstances” is alive and well with respect to those limitation periods. We will have to wait and see.

Hurricane Ike Insurance Litigation: Will It Be As Bad As Katrina?

martin@mdjwlaw.com (Chris Martin) — Mon, 17 Nov 2008 22:28:49 GMT

It didn’t take long for the first bad faith suits arising from Hurricane Ike to be filed in Texas. Last week, the first two Ike bad faith lawsuits that I am aware of were filed in Galveston and Ft. Bend Counties. In Fort Bend County, a breach of contract suit was filed last week titled Gatesco Inc. v. Steadfast Insurance Company in which plaintiffs claim the insurer failed to pay policy benefits after its property sustained damages during Ike. On November 7th, an Ike bad faith lawsuit was filed in Galveston County titled Williamson v. Brown & Brown Insurance Services of Texas and Chubb Lloyds Insurance Company of Texas for alleged failures to pay Ike-related damages. These are first of several thousand Ike lawsuits expected to be filed across Southeast Texas over the next several years. There doesn’t appear to be anything uniquely significant about them other than their apparently quick filing so soon after the storm. The big question being asked by carriers across the country is whether Hurricane Ike will generate the type and volume of litigation generated by Hurricane Katrina.

In the three years since Hurricane Katrina, it has been estimated that between 27,000 and 30,000 hurricane insurance suits were filed in southern Louisiana alone. Of the 12,565 suits filed in federal court, only slightly more than half -- 7,837 -- cases, have gone to judgment or settled. Some federal court judges have attempted to streamline the flow of cases by issuing form orders applicable only to Katrina-related cases. These efforts have not moved cases as quickly as was hoped and one federal judge recently predicted in an interview that it will be “a couple more years” to settle or try all the Katrina insurance litigation. Some of these cases have provided an opportunity to obtain clarification of the law on critical issues such as whether the flood exclusion in most Louisiana homeowner policies is ambiguous, whether Louisiana’s Valued Policy Law statute compels an insurer to pay policy limits even when some or most of the damage is attributable to a non-covered peril, and the extent to which recovery under a homeowners policy can be offset by prior flood policy payments. Much of what remains in New Orleans Katrina homeowner lawsuits are the many diverse individual claims that were initially brought as part of the several mass joinder lawsuits and are which now being evaluated for individual treatment.

With Hurricane Ike hitting Houston and the surrounding areas hard, many carriers are wondering whether Ike will be “Katrina II” in terms of the legal circus seen in Mississippi and Louisiana over the last three years. For several reasons, I don’t think so.

First, in Katrina the residents and business owners of New Orleans and the surrounding parishes saw much more extensive flood damage than Houston and its surrounding counties. Certainly Galveston, Orange and Jefferson Counties experienced significant flooding in Ike, but it didn’t involve anywhere near the numbers seen in Katrina. Second, the insurance laws have developed differently in Texas than in Louisiana or Mississippi. Texas, unlike Louisiana, has much better developed case law on flood coverage, wind damage, concurrent causation, and burden of proof issues. Texas has an extensive body of established case law on bad faith in contrast to Louisiana and Mississippi. Texas has two year and four year limitations periods in contrast to Louisiana’s one-year prescription period (that was extended by the Louisiana Legislature for Katrina claims). This will not only allow for the more “orderly” progression of the filing new suits, it will also lead to less suits being filed prematurely (which we saw in Louisiana with Katrina suits in the days before the running of the prescription period.) The required Texas Windstorm Coverage in coastal counties will result in more concentrated efforts to separate wind from flood damage than was seen in Katrina. Texas won’t have the “VPL” coverage fight the industry underwent in Katrina. Texas has more stringent class action requirements so less class action lawsuits are likely in Texas than we saw in Katrina. Texas has also utilized the Multi-District Litigation Panel concept much more than in Louisiana or Mississippi, including recently in Hurricane Rita litigation which might result in more easily managed individual litigation (at least at the pre-trial stage).

The differences in Ike litigation, however, may not all be considered good by carriers. The scope of litigation will be more geographically widespread. Most of the Katrina suits were centered in the state and federal courts New Orleans and Gulfport, MS. The Ike litigation will be extensive in the 14 Texas counties declared federal disaster areas as well as in as many as a dozen other Texas counties which were not declared disaster areas but which still experienced wind damage. Far more commercial property suits (including business interruption issues) seem likely given the larger number of commercial entities impacted by Ike in metro Houston. Suits in traditionally pro-policyholders venues such as Galveston, Beaumont, and Orange could make individual Ike lawsuits more expensive to resolve than their New Orleans and Gulfport counterparts. The wide diversity in policy forms among homeowner policies in Texas will likely lead to both more issues and more lawsuits as policyholder lawyers attempt to exploit such policy differences. So, while there will be many similarities in the litigation, it is more likely that there will be significant differences between the types, amounts, geographic diversity and costs of Ike lawsuits in comparison to the Katrina lawsuits.

Insurance companies tend to evaluate the value of claims better than plaintiff's counsel.

mthomas@harpergrey.com (Michael Thomas) — Mon, 17 Nov 2008 19:54:10 GMT

Eighty to 92 percent of all cases settle before trial. A recent study by Kiser, “… An Empirical Study of Decision Making in Unsuccessful Settlement Negotiations”, Journal of Empirical Legal Studies, Volume 5, Issue 3, 551?591, September 2008, compares settlement offers to trial results in 2,054 cases that went to trial from 2002 to 2005 in the United States. The study indicates that plaintiff go to trial more often than they should, and that defence counsel, generally are better at evalauting claims than plaintiffs. However, when the defendants make an error in evaluating a claim, they tend to be signficant.

A party is defined as erring in going to trial if the settlement offer that the other side made was greater than the amount awarded at the trial. In 61 percent of the cases that went to trial the plaintiffs erred in going to trial by receiving less than what the defendants offered prior to trial. In 24 percent of the cases the defendants erred in going to trial, as the plaintiffs received more than what they offered to settle the case prior to trial. In 15 percent of the cases, both sides made the right decision by going to trial; the plaintiff received more than the defendant offered prior to trial, but the defendant paid less than what the plaintiff demanded before trial.

When the plaintiffs make the wrong decision, on average it cost them about $43,000, that is, the award on average was $43,000 less than what they expected. Plaintiff decision?making is particularly poor in medical malpractice cases where the decision error for plaintiffs was 81 percent. Parties were better off in going to trial only 4.1 percent of the time in medical malpractice cases. With respect to other personal injury cases, both parties were better off going to trial 20.5 percent of the time, the defendant was better off going to trial 53.2 percent of the time, and the plaintiff was better off going to trial 26.3 percent of the time. Although the defendants made a wrong decision less often, when they were wrong, they paid out on average $1.1 million more than their offer for a wrong decision.

Kiser also looked at the effect of forum on the plaintiff and defendant errors in going to trial. Jury trials had a significant impact on a plaintiff’s ability to correctly predict whether to proceed to trial. Sixty?four percent of plaintiffs rejected a settlement offer to their detriment in jury trials, whereas defendants only made an error in proceeding to trial by jury 22 percent of the time. Bench trials did not significantly alter either party’s ability to predict outcome. Interestingly, counsel experience also did not play a factor in a party’s ability to properly elect to settle or proceed to trial.

Insurance companies and their lawyers tend to evaluate the value of claims better than plaintiffs' counsel.

mthomas@harpergrey.com (Michael Thomas) — Mon, 17 Nov 2008 19:54:10 GMT

Excessive Fees in 401(k) Plans: Its What You Do, Not Who You Know, That Counts

srosenberg@mc-ep.com (Stephen D. Rosenberg) — Mon, 17 Nov 2008 16:47:11 GMT

I am a real big fan of this article here, on two recent rulings in major excessive fee 401(k) lawsuits, one against Wal-Mart and the other against Bechtel. While I haven’t read the rulings in those cases themselves yet, what I like about the rulings, at least as depicted in the article, is that they apparently did not focus on the actual amount of the fees, but rather on the process used by the defendant companies in selecting them, to decide whether the amount of fees attached to the plan’s investment options violated fiduciary obligations. As the article sums up the rulings:

The details in the recent rulings in the Wal-Mart and Bechtel suits vary, but both cases offer a reassuring message to large corporate plan sponsors: In determining whether a corporation breached its fiduciary duties to 401(k) participants, the actual fees charged to workers are not nearly as important as the procedure a sponsor has in place supporting its decision to hire, and keep, any firm that provides 401(k) services to plan participants.

So, for instance, if plan sponsors offer actively managed mutual funds on their 401(k) platforms, sponsors are not acting negligently if these funds wind up underperforming—even if the funds are more costly to participants than passive investment options that could have generated better returns for a lower fee. As long as 401(k) sponsors can document that there was sound reasoning and process underlying its selection of the actively managed funds, then they are not breaching their fiduciary responsibilities.

I like this because it is a perfect match for something I have been preaching on this blog for some time, and which is exactly what I tell reporters who call up asking for suggestions as to how plan sponsors and administrators can best protect themselves against fiduciary liability: follow and document best practices that show that the company tried to locate the best funds at the best fees. Sponsors and fiduciaries can do this by such steps as: (1) bench marking selections against other options and the market as a whole; (2) bringing in outside experts who can provide that information; (3) choosing funds whose costs are consistent with the industry and not outliers; and (4) considering multiple vendors, options and choices before settling on the best overall option, just as the company would in picking vendors for any other service or product. What this really means in the real world as to follow, or mimic, an RFP type approach to selecting funds and vendors, and never, ever, just buy funds from someone a fiduciary knows from playing golf.

Can't Have It Both Ways: ELI Coverage and Workers' Comp Exclusion

sthorpe@gordonrees.com (Sara Thorpe) — Mon, 17 Nov 2008 03:18:27 GMT

While not a new development, this case is a reminder that logic and common sense prevail in evaluating coverage, even in the face of tragedy. The California Court of Appeal for the Fourth Appellate District affirmed an order granting summary judgment in favor of an insurer in an action for breach of the duties to defend and indemnify under a policy’s Employer Liability Insurance (ELI) coverage, holding the underlying claim was within the scope of the workers’ compensation exclusion because it was covered by the workers’ compensation law and the insured did not assert any exceptions applied to the statute. Power Fabricating Inc. v. State Comp. Ins. Fund (2008) __ Cal.App.4^th __ [08 CDOS 13719].

This claim arose out of a fatal electrocution in the course of employment. State Compensation Fund issued insurance to Power Fabricating Inc., which afforded coverage for workers’ compensation and ELI coverage. State Fund paid workers’ compensation benefits to the deceased employee’s widow. However, the widow also sued Power and a related entity, Power Temporary Systems, Inc. (“PTSI”). Power tendered the suit to State Fund which denied coverage. Power then sued State Fund for breach of contract. The trial court granted summary judgment for State Fund.

On appeal, Power argued summary judgment was inappropriate because there was a disputed issue of fact as to whether Power, PTSI, or a joint venture of the two entities, was the deceased’s employer at the time of the accident. Power contended ELI coverage would apply if the deceased was an employee of the joint venture and was injured by Power’s negligent acts or Power’s employee but injured by acts of the joint venture for which Power was derivatively liable. The court disagreed, holding that ELI coverage only applied to injury arising out of or in the course of employment by the insured. To the extent the joint venture, as an entity distinct from either Power or PTSI, employed the deceased, the ELI coverage would not apply in the first instance. The court held Power could not invoke coverage under the ELI provisions, which required employment by an insured, but then attempt to avoid application of the worker’s compensation exclusion on the theory a non-insured entity was actually the employer.

The court also rejected Power’s second argument, holding the workers’ compensation exclusion would apply to Power’s derivative liability for the joint venture. The complaint alleged only Power, not PTSI, was negligent, eliminating any risk of derivative liability. Even if that risk existed, Power’s derivative liability did not fall within any exception to the workers’ compensation law.

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Insurance companies tend to evaluate the value of claims better than plaintiff's counsel.

Insurance companies and their lawyers tend to evaluate the value of claims better than plaintiffs' counsel.

Excessive Fees in 401(k) Plans: Its What You Do, Not Who You Know, That Counts

Can't Have It Both Ways: ELI Coverage and Workers' Comp Exclusion