EmbroidMe.com, Inc. v. Travelers Property Casualty Co. of America

In April 2010, Plaintiff and Appellant EmbroidMe.com (“EmbroidMe”) was sued for copyright infringement by JCW Software LLC (“JCW”), which alleged that EmbroidMe “had improperly distributed copies of the former’s ‘Fast Manager’ software program in violation of a 2007 settlement agreement.” Prior to the lawsuit, EmbroidMe had purchased a commercial general liability insurance policy from Defendant and Appellee Travelers Property Casualty Company of America (“Travelers”), and both EmbroidMe and Travelers agreed that the policy would provide defense and indemnity for the lawsuit. However, the parties did not reach this consensus at the beginning of the JCW lawsuit, because EmbroidMe had chosen not to provide notice of the lawsuit to Travelers and, instead, hired and paid counsel directly for EmbroidMe’s defense. Only after there had been fourteen months of litigation and $405,000 in legal fees incurred did EmbroidMe provide Travelers with notice of the lawsuit.

EmbroidMe provided notice of the lawsuit to Travelers on October 10, 2011. Travelers’ case handler and general counsel discussed the claim three days later and issued a reservation of rights letter on November 21, 2011. It was in this reservation that Travelers acknowledged its defense and indemnity obligations, subject to any coverage defenses that may arise in its fact investigation of the claim. The reservation also addressed Travelers’ right to control the defense, but stated that Travelers was amenable to retaining EmbroidMe’s chosen counsel if certain “factors, including rates” could be addressed to Travelers’ satisfaction. After months of negotiations, Travelers agreed on February 20, 2012, to pay EmbroidMe’s attorneys the rate of $315/hour, which was a reduction of $85/hour from the attorneys’ usual rate. The new rate was imposed retroactive to the date of tender, and EmbroidMe’s defense continued and was paid by Travelers during the rate negotiations.

On March 1, 2012, EmbroidMe wrote to Travelers, stating its belief that Travelers continued to owe reimbursement for EmbroidMe’s pre-tender defense costs. The following June, JCW filed a second lawsuit against EmbroidMe, and shortly thereafter, the district court dismissed the cause of action in the original lawsuit that had triggered Travelers’ initial defense and indemnity obligations. The district court also ordered the parties to mediation, which resulted in the settlement of both lawsuits on August 14, 2012. At all times through this date, Travelers continued to defend EmbroidMe.

After the settlement, Travelers wrote to EmbroidMe and re-stated its position that it owed no reimbursement for EmbroidMe’s pre-tender defense costs. Two months later, EmbroidMe filed a breach of contract action against Travelers in state court, which Travelers promptly removed to the U.S. District Court for the Southern District of Florida. Each party filed a motion for summary judgment, with EmbroidMe asserting that “Travelers was estopped from denying its duty to pay pre-tender fees and costs because its communication of that denial was made after the deadline set for notification of coverage defenses by Florida’s ‘Claims Administration Statute’ (Fla. Stat. § 627.426 (1983)).” EmbroidMe.com, Inc. v. Travelers Property Casualty Co. of America, 2017 WL 74694, at 3.

Travelers, on the other hand, argued that “the policy provisions excluding it from any responsibility to pay legal fees incurred by the insured without its prior approval constituted an exclusion, not a defense to coverage of a claim” and that Florida’s Supreme Court had held that the Claims Administration Statute (“CAS”) applied only to coverage defenses, and not to coverage exclusions. Id. The district court agreed with Travelers and held that it had no obligation to reimburse EmbroidMe for legal expenses “unilaterally incurred prior to tendering the claim to Travelers and during the time when EmbroidMe had chosen to handle its defense with no involvement by Travelers.” Id. EmbroidMe appealed.

Based on the district court’s diversity jurisdiction, the Eleventh Circuit applied Florida law to the dispute. Initially, the Court of Appeals determined that there was no Florida case “squarely addressing the facts of this case” and that it was constrained by “the interpretation that Florida law has given” to the terms “exclusion” and “coverage defense” in other disputes. Id. at 4. Prior to delineating these interpretations, however, the Court of Appeals was quick to point out that the “voluntary payments” provision expressly required an insured to seek the consent of Travelers before incurring any pre-tender expenses for which the insured would seek reimbursement. Id. at 5. The Court found the policy language to be clear and even went so far to imply that common sense “would alert even the most unsophisticated insured to the reality that, if sued, it could not expect its insurer to reimburse it for attorney’s fees it unilaterally incurred…” Id.

Nonetheless, EmbroidMe maintained that invocation of the voluntary payments provision was akin to a coverage defense, thereby falling into the notice requirements of the CAS. Id. at 6. In rejecting this argument, the Court of Appeals relied on the legal differences between an insurer’s duty to defend and its duty to indemnify. Id. at 6. The former duty is dictated by the allegations of a claim and the potential that said allegations could fall into the scope of a policy’s coverage. See Id. (author’s emphasis). The latter duty arises only after all necessary fact finding has been completed and it is determined that the subject conduct or occurrence is covered by the policy. Id. Thus, because there are two different standards – potential and actual coverage – triggering the respective duties, the analysis for each duty is exclusive of the other. Id.

In finding that the “voluntary payments” provision was an exclusion, and not a coverage defense, the Eleventh Circuit cited heavily to AIU Insurance Co. v. Block Marina Investment, Inc., 544 So.2d 998 (Fla. 1989) and the numerous cases applying Block Marina to various forms of insurance exclusions. See Id. at 8-9 (internal citations omitted). The underlying tenet of Block Marina is that a violation of the CAS cannot be used to extend coverage to claims that are expressly excluded from coverage in the policy. Id. at 9 (citing Block Marina, 544 So.2d, at 999-1000). In supporting this decision, the Eleventh Circuit noted that the CAS is typically only applied to questions of indemnity, rather than to defense, and that the only remedy provided for a violation of the CAS is the preclusion of a defense to an indemnity obligation. Id. at 9-10 (“[I]t is no surprise that, with one exception, we have found no Florida case that has applied the CAS for purposes of remedying an alleged breach of a duty to defend.”).

The one exception found by the Eleventh Circuit was Nationwide Mutual Fire Ins. Co. v. Beville, 825 So.2d 999 (Fla. 4th DCA 2002), which was the main case argued by EmbroidMe. However, the Court of Appeals found numerous flaws in its application. First, Beville never addressed the question of where an award of defense costs was expressly authorized by the CAS. EmbroidMe, supra, at 11. Second, the Beville court noted “that even if the CAS were not applicable, it would still require reimbursement of the insured’s previously-incurred attorney’s fees because there had been ‘no suggestion that the insured’s expenses in defending…were unreasonable or in some way prejudiced the carrier.’” Id. at 12 (citing Beville, 825 So.2d at 1004). EmbroidMe, on the other hand, had paid its attorneys substantially more than Travelers was willing and ultimately agreed to pay, thereby prejudicing Travelers. Id.

And finally, the policy provision at issue in Beville was the “notice” provision, which obligated the insured to provide prompt notice of a lawsuit to its insurer, but otherwise did not exclude coverage for the subject claim. Id. A breach of this obligation “gives an insurer a defense to coverage that otherwise exists.” Id. (author’s emphasis). In its “voluntary payments” provision, Travelers required that the insured receive Travelers’ consent to incur defense fees, if the insured intended to seek reimbursement of same. Id. The Court of Appeals responded as follows: “This provision clearly excludes any voluntary payments made by an insured without the insurer’s permission. It is an exclusion from coverage, and there is no dispute that EmbroidMe disregarded it.” Id. Based on these distinguishing factors, the Eleventh Circuit found the “voluntary payments” provision to constitute an exclusion, thereby placing it outside the notice requirements of the CAS.