3rd Cir. Holds No TCPA Coverage Under Business Owners Insurance Policy

This article was originally published on the Maurice Wutscher blog and is republished here with permission.

The U.S. Court of Appeals for the Third Circuit recently held that a business-owners insurance policy did not cover a class action judgment that arose out of unsolicited advertisement communications in violation of the federal Telephone Consumer Protection Act.

A copy of the opinion in Auto-Owners Insurance Company v. Stevens & Ricci Inc. is available here.

A business was solicited by an advertiser who claimed to have a fax advertising program that complied with the TCPA, 47 U.S.C. § 227. The business allowed the advertiser to fax thousands of advertisements to potential customers on its behalf.

Six years later, a class action lawsuit was filed against the business, claiming that the advertisements violated the TCPA, which prohibits the “use [of] any telephone facsimile machine, computer, or other device to send, to a telephone facsimile machine, an unsolicited advertisement …”

In the class action, the class representative asserted that it had neither invited nor given the business permission to send the faxes, and that the unsolicited faxes had damaged the recipients by causing them to waste paper and toner in the printing process, lose the use of their fax machines when the advertisements were being received, and the faxes had also interrupted the class members’ “privacy interest.”

During the time that the unsolicited faxes were sent to the class members, the business was covered by a business owners insurance policy. The policy obligated the insurer to “pay those sums that the insured becomes legally obligated to pay as damages because of ‘bodily injury’, ‘property damage’, ‘personal injury’ or ‘advertising injury’ to which this insurance applies.”

The insurer agreed to defend the business in the class action, but reserved its right to later challenge whether the sending of unsolicited faxes fell within the terms of the insurance policy’s coverage.

One year later, the class action settled and the parties agreed to entry of judgment in favor of the class against the business for $2 million. The class also agreed to seek recovery of the judgment only from the insurer. The trial court entered an order and final judgment approving the settlement and entering the judgment against the business. In its order, the trial court specifically found that the business “did not willfully or knowingly violate the TCPA.”

By that time, the insurer had already filed a declaratory judgment action against the business to clarify its obligations under the policy and seeking a declaration that the policy did not provide coverage for the claims in the class action and that the insurer did not owe the business any duty to defend or indemnify.

The insurer and the class representative each moved for summary judgment in the declaratory judgment action, and the trial court concluded that the sending of unsolicited faxes to the class members did not cause the sort of injury that fell within the policy’s definition of either “property damage” or “advertising injury.” The trial court granted the insurer’s motion for summary judgment and denied the class representative’s cross-motion. The class representative appealed.

On appeal, the class representative first argued that the trial court did not have jurisdiction to hear the case. The insurer had brought its declaratory relief action under the Declaratory Judgment Act, 28 U.S.C. § 2201.

As you may recall, the DJA does not itself create an independent basis for federal jurisdiction, but instead provides a remedy for controversies otherwise properly within the court’s subject matter jurisdiction. Skelly Oil Co. v. Phillips Petroleum Co., 339 U.S. 667, 671-72 (1950). Declaratory judgment actions do not directly involve the award of monetary damages, but “it is well established that the amount in controversy [in such actions] is measured by the value of the object of the litigation.” Hunt v. Wash. State Apple Advert. Comm’n, 432 U.S. 333, 347 (1977).

In bringing its declaratory judgment action, the insurer had invoked diversity jurisdiction, which requires that the parties must be completely diverse, meaning that “no plaintiff can be a citizen of the same state as any of the defendants,” and that the “matter in controversy exceeds the sum or value of $75,000.” 28 U.S.C. § 1332.

Here, there was no dispute that the parties were completely diverse, because the insurer was based and incorporated in Michigan, while the business was based and incorporated in Arizona, and the class representative was based and incorporated in Pennsylvania.

However, although the business and the class representative were ultimately fighting over the insurer’s obligation to pay a $2 million judgment against the business, that judgment was based on the settlement of the underlying class action lawsuit in which the individual claims of each class member fell well below the $75,000 amount-in-controversy threshold.

In general, the distinct claims of separate plaintiffs cannot be aggregated when determining the amount in controversy. Werwinski v. Ford Motor Co., 286 F.3d 661, 666 (3d Cir. 2002).

The class representative argued that the insurer, by adding up the potential damages owed to each of the various class members, improperly aggregated those claims to cross the jurisdictional threshold. The class representative argued that this action was a multi-party dispute between the insurer and the multiplicity of class claimants.

The insurer disagreed, arguing that the case was only between it and its insured — the business. The insurer argued that in coverage litigation commenced by an insurer, the focus is on the amount the insurer will owe to its insured or the value of its coverage obligation.

Given those two competing positions, the Third Circuit had to decide whether the case was a dispute between the insurer and the many class members (which would give rise to aggregation problems) or a dispute between the insurer and its insured concerning its overall obligation to defend and indemnify under the policy.

The Court had never previously addressed this question, and therefore relied on the opinion of the U.S. Court of Appeals for the Seventh Circuit in Meridian Security Insurance Company v. Sadowski, 441 F.3d 536 (7th Cir. 2006). There, much like this case, an insurer sought a declaratory judgment against its insured to avoid any obligation to defend a class action alleging that the insured had sent unsolicited fax advertisements in violation of the TCPA.

In Sadowski, as in this case, the underlying class action was still pending at the time the declaratory judgment action was filed. In Sadowski, the Seventh Circuit concluded that the district court indeed had diversity jurisdiction, and rejected the very same argument that the class representative advanced in this case.

According to Sadowski, the “insurer [had] not aggregated multiple parties’ claims. From its perspective there was only one claim – by its insured, for the sum of defense and indemnity costs.” The Seventh Circuit thus held that “the anti-aggregation rule does not apply … just because the unitary controversy between these parties reflects the sum of many smaller controversies.”

The Third Circuit adopted the Sadowski reasoning. Viewing this case from the perspective of the insurer at the time of filing of the declaratory judgment complaint, the Court held that the insurer’s quarrel was with the business regarding its indemnity obligation under the policy. According to the Court, the only “amount in controversy” that the insurer was then concerned with was its total indemnity and defense obligation. Thus, the Court held that the insurer’s dispute was thus with its insured, not the class, and its overall liability was not legally certain to fall below the jurisdictional minimum.

Accordingly, the Third Circuit held that satisfaction of the amount-in-controversy requirement did not violate the anti-aggregation rule, and the trial court had diversity jurisdiction under 28 U.S.C. § 1332.

The ultimate question was whether the sending of the faxes fell under the policy’s definition of either “property damage” or “advertising injury,” as a matter of state law.

First, however, the Court of Appeal had to determine which state’s law to apply. Chamberlain v. Giampapa, 210 F.3d 154, 158 (3d Cir. 2000).

Because the policy did not contain a choice-of-law provision, the Court of Appeals had to apply the choice of law rules of the forum state to determine which state’s substantive law applied. Kruzits v. Okuma Mach. Tool, Inc., 40 F.3d 52, 55 (3d Cir. 1994). As in all applications of state law, the Court’s task was to predict how the state Supreme Court would rule if it were deciding the case. Norfolk S. Ry. Co. v. Basell USA Inc., 512 F.3d 86, 91-92 (3d Cir. 2008).

The insurer urged the Court of Appeal to apply Pennsylvania law, because Pennsylvania was the forum state for both the declaratory judgment case and the class action.

The class representative, however, argued that Arizona law should apply, emphasizing the many connections between the policy and that state – i.e., the business was based and incorporated there; the underwriting file on the policy indicates that the insurance quote was by an agency based in Arizona; the application for insurance was submitted to the insurer’s branch in Arizona and reviewed by an underwriter there; and the decision to insure the business was made entirely within the Mesa, Arizona branch. Essentially, the class representative argued that Arizona law should apply because that is where the insurance contract was formed.

Because the action was filed in the Eastern District of Pennsylvania, the Third Circuit applied Pennsylvania choice-of-law rules.

Before 1964, Pennsylvania courts applied the law of the place where the contract was formed (“lex loci contractus”). That stood in contrast to the rule in tort cases, which required application of the law of the place where the injury occurred (“lex loci delicti”). In Griffith v. United Air Lines, Inc., the Pennsylvania Supreme Court abandoned the “lex loci delicti” rule for torts “in favor of a more flexible rule which permits analysis of the policies and interests underlying the particular issue before the court.”

The Griffith court did not address whether its new flexible approach to choice-of-law questions would also apply to contract claims, thus also displacing the “lex loci contractus” rule. Nor had the Supreme Court of Pennsylvania ever addressed that issue.

The Third Circuit had, however, addressed this issue twice before. Almost 40 years ago, in Melville v. Am. Home Assurance Co., 584 F.2d 1306, 1312 (3d Cir. 1978), it predicted that Pennsylvania would extend its Griffith methodology to contract actions.

More recently, in Hammersmith v. TIG Insurance Co., 480 F.3d 220, 226-29 (3d Cir. 2007), the Third Circuit again concluded that Pennsylvania would apply Griffith’s flexible approach to choice-of-law questions in contract cases, noting that in Budtel Associates, LP v. Continental Casualty Company, the Pennsylvania Superior Court had concluded that the Commonwealth’s precedents mandated that it follow the Griffith rule in the contract law context.

The class representative argued that the previous “lex loci contractus” rule should control and that the Third Circuit should apply Arizona law. The Court rejected the class representative’s arguments, noting that the class representative cited no intervening Pennsylvania authority that called the Court’s prediction in Hammersmith into question. Accordingly, the Court applied Griffith’s flexible choice-of-law analysis.

Under the Griffith approach, “the first step in a choice of law analysis under Pennsylvania law is to determine whether a conflict exists between the laws of the competing states.” If there are no relevant differences between the laws of the two states, the court need not engage in further choice-of-law analysis, and may instead refer to the states’ laws interchangeably.

To determine whether a conflict existed, the Third Circuit had to decide whether Arizona and Pennsylvania law disagreed on the proper scope of the coverage applicable in this case.

The class representative argued that there were two significant conflicts between Arizona and Pennsylvania substantive law. First, it argued that a basic Pennsylvania principle of contract interpretation – that courts enforce unambiguous policy language – did not apply to the interpretation of insurance contracts under Arizona law. Instead, the class representative argued that Arizona courts interpret insurance contracts by looking to the reasonable expectations of the insured.

According to the class representative, in Arizona, even clear and unambiguous boilerplate language is ineffective if it contravenes the insured’s reasonable expectations.

The Third Circuit observed that the class representative was using the “reasonable expectation” test to conduct a 50-state legal survey and to argue that Arizona’s law must be whatever the prevailing legal theory was across the country since that prevailing law is inherently “reasonable.”

The class representative argued that in order for the insurer to show that its policy interpretation was consistent with a reasonable insured’s expectations, the insurer must demonstrate that the interpretation adopted explicitly or implicitly by courts nationwide is unreasonable.

The Third Circuit rejected the class representative’s argument. To begin with, the Court did not agree with the class representative that there was a conflict, noting that both states gave dispositive weight to clear and unambiguous insurance contract language. But, even if a conflict had existed, the court held that the class representative failed to explain how or why using the “reasonable expectation” test would result in a conflict in the applicable substantive law.

Therefore, the Court rejected the class representative’s argument, noting that the argument misstated the nature of the Court’s inquiry. When sitting in diversity and conducting a choice-of-law analysis pursuant to Pennsylvania conflict principles, the Court’s job is only to evaluate any conflict between the laws of Arizona and Pennsylvania.

The class representative, however, had failed to argue that those two states’ laws were different in any way that actually changed the meaning of either of the relevant terms of the policy: “property damage” or “advertising injury.”

The Court noted that the class representative’s argument was thus not only wrong on the law (the states’ laws did not conflict in how they interpreted insurance contracts), but was also irrelevant because it failed to connect the purported conflict to the applicable law.

The class representative’s second alleged conflict was more tenable and related to the differing interpretations of Arizona and Pennsylvania courts as to the meaning of “property damage.”

The policy required that any covered “property damage” be caused by an “occurrence,” which is defined as an “accident.” The policy did not define the term “accident,” although it did exclude from coverage any property damage “expected or intended from the standpoint of the insured.”

The class representative argued that the two states define an “accident” differently. It argued that the two states’ laws conflicted over whether an insurance policy that covers “accidents” would extend to the “unintended consequences of intentional acts,” in this instance, damage to a fax recipient from an intentionally sent fax.

The class representative argued that Pennsylvania law would result in such damages being excluded from coverage, whereas Arizona law would cover its claim as an “accident.”

Once again, the Court rejected the class representative’s argument, noting that under both Pennsylvania and Arizona law the claim would be excluded from coverage.

The Court relied on the Supreme Court of Pennsylvania case of Donegal Mutual Insurance Co. v. Baumhammers, 938 A.2d 286, 292 (Pa. 2007), where the Supreme Court of Pennsylvania said that when “accident” is undefined in an insurance policy, Pennsylvania courts should treat the term as “refer[ing] to an unexpected and undesirable event occurring unintentionally ….”

Baumhammers stood for the premise that even intentional acts of third parties could still be a covered “accident.” Baumhammers involved a killing spree perpetrated by the son of the insured. The estates of several of the victims sued both the son and his parents, alleging, among other claims, negligence on the part of the parents “in failing to take possession of [his] gun and/or alert law enforcement authorities or mental health care providers about [their son’s] dangerous propensities.” The parents sought coverage under their insurance, which covered claims for bodily injury caused by an “accident.”

The Supreme Court of Pennsylvania held that, with respect to the insured parents, the shootings qualified as an “accident” under the policy, because “[t]he extraordinary shooting spree embarked upon by [the son] resulting in injuries to [the victims] cannot be said to be the natural and expected result of [his parent’s] alleged acts of negligence.” Thus, the injuries were caused by an event so unexpected, undersigned, and fortuitous as to qualify as accidental within the terms of the policy.

Here, by contrast, the Third Circuit noted that the class representative’s claimed injury was the use of ink, toner, and time that was caused by the receipt of junk faxes, which were the natural and expected result of the intentional sending of faxes, a far cry from Pennsylvania’s definition of an “accident.”

Although it did not intend injury, the business clearly intended for the third-party advertiser to send the fax advertisements to the members of the class. The Court, concluding that Pennsylvania courts would reject coverage of the claim, observed that any sender of a fax knows that its recipient will need to consume paper and toner and will temporarily lose the use of its fax line.

The Court rejected the class representative’s argument that Arizona law would cover its claim as an “accident,” noting that Arizona law defines an “accident” much the same as Pennsylvania law, relying on Lennar Corp. v. Auto-Owners Ins. Co., 151 P.3d 538, 547 (Ariz. Ct. App. 2007), and Lennar Corp. v. Auto-Owners Ins. Co., 151 P.3d 538, 547 (Ariz. Ct. App. 2007).

Thus, the Court concluded that there was no conflict between Pennsylvania and Arizona law on the question of whether the damage to the class members was covered under the policy’s definition of “property damage,” holding that under either state’s law, there is no coverage because the alleged injury was not the result of an “accident.” It was the foreseeable result of the intentional sending of faxes to the class recipients.

Finally, the class representative argued that coverage was available because the damage to class members from receipt of the junk faxes qualified as “advertising injury” under the policy. Because the class representative did not contend that the Arizona definition of “advertising injury” differed from Pennsylvania, the Court looked solely to Pennsylvania law to answer that question.

The Court again rejected the class representative’s argument, concluding that the claimed injury fell outside of the scope of the policy’s coverage.

The policy defined “advertising injury” as, among other things: “Oral or written publication of material that violates a person’s right of privacy.” Although the policy did not define the term “privacy,” numerous state and federal courts have considered whether violations of the TCPA are covered by insurance policies that include similar or identical language to that at issue.

The Third Circuit relied on the Pennsylvania Superior Court case of Telecommunications Network Design v. Brethren Mutual Insurance Co., which divided “right of privacy” into two broad categories: the privacy interest in secrecy and the privacy interest in seclusion. Secrecy-based privacy rights protect private information, while seclusion-based privacy rights protect the right to be left alone.

Citing Melrose Hotel Co. v. St. Paul Fire & Marine Ins. Co., 432 F. Supp. 2d 488, 502 (E.D. Pa. 2006),aff’d, 503 F.3d 339 (3d Cir. 2007), the Court noted that the TCPA protects only the privacy interest in seclusion by shielding people from unsolicited messages. The content of the messages is immaterial under the TCPA.

Observing that an unsolicited fax intrudes upon the right to be free from nuisance, the Third Circuit held that the purpose of the TCPA is consistent with the type of injury that the class representative alleged in its complaint.

The Court found, however, that the policy’s protection of the “right of privacy” was limited to a privacy interest the infringement of which depends upon the content of the advertisements: in other words, the privacy right to secrecy.

The Court relied on the Pennsylvania Superior Court case of Telecommunications Network Design v. Brethren – a case involving the exact same questions: identical policy language; identical underlying TCPA violation, and identical claimed damages for that violation – in which the state court ruled that the policy did not cover that injury, because the class representative’s allegations in the class action did not relate to the content of the faxed advertisements. According to the state court in Brethren, the faxes caused the alleged damage because they were received without permission, not because of their content. At no point did the class representative allege that the unsolicited faxes included confidential or otherwise secret information about any of the class members.

Thus, the Third Circuit found that the class representative’s claims were not covered under the policy, and affirmed the judgment of the District Court.