The unpublished opinion of the Eleventh Circuit in Wellons Inc. v. Lexington Insurance Company 2014 WL 1978412 (11th Cir. 2014) is yet another federal court decision which ignores the insured’s substantive insurance rights under state law. The great divide between “State Court Justice” and “Federal Court Justice” continues to widen and thereby frustrates our constitutional system.

In Wellons, the Eleventh Circuit was asked to decide whether a series of prior, general reservation of rights letters by Lexington (AIG) preserved Lexington’s right to deny coverage after a lawsuit was filed and Lexington undertook the defense. The Wellons claim involved the construction of a dryer energy thermal oxidation system to produce heat for production of oriented strand board (OSB), customarily used in home construction and flooring. After the initial energy system was built and placed in operation, leaks developed in the superheater where steam passed before being sent to the turbine. Testing allegedly revealed leaks in a substantial number of the joints, which were then repaired.  Approximately two weeks later, one of the superheater tubes completely severed and resulted in the owner’s call for a replacement of the superheater, as well as damage to most of the tubes in the energy system.

Wellons placed Lexington on notice of the claim before suit was filed. Lexington’s “reservation of rights” letter advised Wellons that it had no obligation to defend or indemnify Wellons for the claim, explaining that: “it is unclear exactly what Langboard’s claims of injury are, beyond the demand that the superheater be replaced. As a result, at this time, Lexington has no duty to indemnify Wellons….” (Wellons v. Lexington, page 8). Thus, Lexington’s initial coverage position was that it was denying coverage, yet reserving rights as well—a position completely unsupportable under Georgia law. See, e.g., Hoover v. Maxum Indemnity Company, 730 S.E. 2d 413 (Ga. 2012). Thereafter, suit was filed against Wellons and Lexington was placed on notice of the suit.  Lexington’s adjuster then orally advised Wellons’ insurance agent that it was going to provide a defense under a general reservation of rights, without specifying any particular coverage defenses. The adjuster stated Lexington’s prior reservation of rights letters were “in the same mode” and “the issues addressed in each of the letters are still applicable.” Lexington did not issue a new reservation of rights letter after suit was filed, but instead assigned defense counsel to defend Wellons in the lawsuit.

After participating in discovery and completing multiple depositions, Lexington’s chosen panel defense counsel were preparing for trial alongside independent counsel chosen by Wellons to assist in the trial.  On the Friday before the Monday of the beginning of the jury trial, Lexington emailed a letter to Wellons denying all coverage for the lawsuit, claiming that discovery revealed that the losses sustained did not meet the definition of either “occurrence” or “property damage” under the CGL policy. Although denying coverage outright, Lexington nevertheless continued the defense of Wellons at trial. The jury awarded $8,440,764.00 against Wellons.

Three months after the jury verdict, Wellons filed a declaratory judgment action against Lexington arguing that the verdict was a covered loss under the CGL policy (and an excess policy also issued by a sister AIG company) because Lexington failed to adequately reserve its rights and was now estopped from asserting any coverage defenses.

On cross-motions for summary judgment, the district court concluded Lexington was not estopped from denying coverage under the CGL and the excess policies and entered judgment accordingly. Wellons appealed to the Eleventh Circuit which held that, “under Georgia law, an insurer need not inform the insured of the specific basis for the insurer’s reservation of coverage.”  The Eleventh Circuit’s decision turned on the interpretation of the Georgia Supreme Court decision in World Harvest Church, Inc. v. GuideOne Mutual Insurance Company, 695 S.E. 2d 6 (Ga. 2010). Interestingly, it was the Eleventh Circuit who had certified those very questions to the Georgia Supreme Court in World Harvest governing an insurer’s requirements for reservation of rights letters.  In World Harvest, the Georgia Supreme Court specifically held as follows: “At a minimum, the reservation of rights must fairly inform the insured that, notwithstanding the insurer’s defense of the action, it disclaims liability and does not waive the defenses available to it against the insured.  The reservation of rights should also inform the insured of the specific basis for the insurer’s reservations about coverage….” (Quotations and citations omitted).  Apparently dissatisfied with the Georgia Supreme Court’s decision, the Eleventh Circuit in Wellons interpreted the above language to mean that an insurer “must fairly inform the insured that the insurer is providing a defense under reservation of rights,” but that an insurer “may” inform the insured of the specific basis for the insurer’s reservation of coverage. The Eleventh Circuit interpreted the word “should” in the World Harvest decision to mean only “recommend.” Therefore, as the Eleventh Circuit read World Harvest, the Georgia Supreme Court was simply making a recommendation or was providing an advisory opinion to the insurance industry about how it might treat its insureds.

The Eleventh Circuit decision in Wellons flatly disregards the plain meaning of the Georgia Supreme Court’s decision in World Harvest. Moreover, the Court goes on to find that Hoover, supra, did not apply despite the fact that Lexington denied coverage outright while purportedly reserving its rights by continuing to participate in the defense of the case at trial.

Much of the subsequent public commentary regarding the Wellons decision surrounds what the current obligations of an insurer might be under Georgia law. Is the insurer required to provide specifics to its insured when it is informing the insured that it might ultimately deny coverage while still providing and managing the defense? May the insurer deny coverage but still participate in the defense of the claim without waiving its defenses or being estopped from later denying coverage?  While commentators continue debating this issue, the focus of debate seems to miss the forest for the trees, in our view.  The Wellons decision is yet another example of the disparity an insured faces when it goes into a federal court versus a state court.  Here, the Eleventh Circuit has read out key provisions of two Georgia Supreme Court cases in order to find for the insurer.  Based on the facts of the case, there seems to be little doubt that the Wellons case would have been decided differently had it been within the Georgia state court system and governed by the decisions in Hoover and World Harvest. Because Erie v. Tompkins and its progeny protect important constitutional rights, there are limits to how far federal courts can go in either ignoring previous state court decisions (and thereby imposing their own personal view of what state law “should” be by declining to follow those precedents), or failing to utilize the certification process to obtain state supreme court opinions.  Wellons is but another example of how the Erie system has been derailed.

Refusing to certify important insurance policy contract cases infringes on the constitutional right of a state’s highest court to decide state law, and raises concerns about whether citizens across the country will have a fair opportunity for the constitutional protection and mandate of Erie. There are numerous examples of cases with identical facts and applicable state law travelling on parallel tracks and arriving at two very different destinations.  Wellons provided another opportunity for the court to certify questions to the Georgia Supreme Court if there was some question as to what the Georgia Supreme Court meant in World Harvest when it proclaimed that an insurer “should also” inform the insured of the specific bases for the insurer’s reservation of rights.  While stating that an insurer “also” should inform the insured of specific reasons for reservation after indicating that an insurer “must” fairly inform the insured that it is providing a defense under reservation of rights, it is hard to conceive that the Georgia Supreme Court would be issuing gratuitous (purely dicta) advisory opinions in response to certified questions from the Eleventh Circuit.

Georgia, for example, has a long established certification procedure through constitutional and statutory authority. GA. CONST. ART. VI, § VI, ¶ IV; GA Code ANN. § 15-2-9.  Forty-three states now have certification statutes, so the opportunity to certify questions to the state’s highest court will exist in most cases.  See also J. Goldschmidt, Certification of Questions of State Law, @ 1, 15-17(American Judicature Society 1995). As federal and state courts diverge on important insurance coverage issues such as notice, “occurrence,” “property damage” and allocation – often affecting construction industry clients disproportionately – the choice of forum becomes extremely important to insurers and insureds alike. Insurers remove coverage cases to federal court whenever possible.  Insureds should therefore seek to uphold their constitutional rights under Erie and demand that state law be applied fairly to its claims regardless of whether it is litigating in state or federal court. Naming local insurance agents (who are potentially liable for late notice of claims or obtaining the wrong types of coverage) is one strategy for keeping the case in state court by destroying diversity.  State supreme court certification processes are another avenue if the federal district or appellate courts either ignore or substantially misread clear state supreme court directives, as the Court did in Wellons.

As federal and state courts diverge on important insurance coverage issues such as notice, “occurrence,” “property damage” and allocation – often affecting construction industry clients disproportionately – the choice of forum becomes extremely important to insurers and insureds alike.  It is axiomatic that insurers remove coverage cases to federal court whenever possible.  Insureds should look for creative ways to uphold their constitutional rights under Erie and demand that state law be applied fairly to its claims regardless of whether it is litigating in state or federal court. Naming local insurance agents who are potentially liable for late notice of claims or obtaining the wrong types of coverage for the insured is one strategy for keeping the case in state court (by destroying diversity).