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June 21, 2000


The opinion of the court was delivered by: Robert L. Carter, District Judge.


Plaintiffs Reliance Insurance Company, ("Reliance"), Continental Insurance Company, ("Continental"), and Royal Insurance Company, ("Royal"), (collectively "plaintiffs" or "insurers"), seek a judgment declaring that they are not required under the provisions of a marine multi-liability excess insurance policy ("bumbershoot policy") to indemnify the defendants: Keystone Shipping Company, ("Keystone"), and Intercoastal Bulk Carriers, ("IBC"), (collectively "defendants" or "assureds"), for costs defendants incurred during the arbitration and settlement of a claim brought by New England Power Company ("NEP") seeking costs for a damaged ship defendants sold to NEP under a charter agreement. Alternatively, plaintiffs argue that if defendants' claim is covered under the bumbershoot policy, third party defendant, James Sedgwick of Pennsylvania, Inc., ("Sedgwick"), is required to indemnify them for any costs paid to the defendants.


A. The Charter Agreement Dispute

In 1980, defendants formed an agreement with NEP to build the "Energy Independence," a self-unloading coal transport vessel ("the vessel"), that would be used for transporting NEP coal supplies. (Jt. Or. at 52, ¶ 13).*fn1 The Energy Independence is a "bulk carrier": it spans the length of two football fields, is approximately six stories high, and has five cargo holds composed of bare uncoated, unlined and unpainted steel. (Id. at 53, ¶ 14). The vessel was completed and launched in 1983. (Id. at 52, ¶ 13). From that time forward, it was exclusively engaged in transporting coal from various United States's ports to NEP's New England coal burning plants. (Tr. at 476).

In 1989, Keystone and NEP entered a new agreement controlling the use and disposal of the vessel ("charter agreement"). The charter agreement outlined the terms of NEP's continuing charter of the vessel ("charter provisions"); it also granted NEP the right to purchase the vessel during the charter term ("buy-out provisions"). Specifically, the charter provisions designated IBC, an affiliate of Keystone, as the vessel's "owner"; designated NEP as the vessel's "charterer"; and named Keystone as the vessel's "operator". (Jt. Ex. 115). The charter provisions also required IBC, as "Owner [of the vessel, to] . . . maintain the vessel in class throughout the period of the Charter," and to "exercise due diligence . . . to make the Vessel tight, staunch, strong, seaworthy and in good order and condition." (Jt. Ex. 115) (Charter Agreement, clauses 3 & 6).

The buy-out provisions in the charter agreement set the purchase price for the vessel at an amount sufficient to pay off the vessel's remaining financing costs, and to provide defendants with approximately 5 to 10 million dollars in profit. (Tr. at 429-31). The precise purchase amount for the vessel was computed under calculations in "appendix five" of the charter agreement. (Jt. Ex. 115). During the negotiations of the buy-out provisions, Philip Fisher, the Chief Financial Officer and Vice President of Keystone and the President of IBC, asked Keystone's insurance broker and in-house risk manager, Sedgwick, whether the charter agreement's buy-out provisions could be insured. (Tr. at 348). Charles Achuff, Sedgwick's Vice President, advised Fisher that the buy-out provisions could not be insured under any type of insurance policy. (Id.). The buy-out provisions were then drafted to provide that the vessel was to be sold "as is where is." (Tr. at 338).

In November, 1994, NEP exercised its buy-out option, and defendants opposed the purchase of the vessel. (Jt. Or. at 53, ¶ 20; Tr. at 446-47). The parties submitted their dispute for arbitration, and the arbitration panel ultimately held that NEP had properly exercised its buy-out rights and could terminate the charter and buy the vessel. (Jt. Ex. 116 at 2). The parties then entered a settlement, dated September 10, 1995, which provided that the vessel would be sold to NEP for the purchase price set by appendix five of the charter agreement. (Tr. at 447; Jt. Ex. 166). On September, 28, 1995, defendants delivered the vessel to NEP. (Tr. at 447).

In October, 1995, NEP put the vessel in drydock at Bethlehem Steel in Sparrows Point, Maryland, and conducted surveys to assess the vessel's condition. (Pl. Ex. 11 at 2). The surveys revealed that the vessel's holds were severely wasted, in addition to needing numerous other repairs. (Id.). NEP arranged to have the vessel repaired and, in a letter dated April 22, 1996, informed defendants that the vessel was damaged and that NEP would file a claim against them for $11,173,732.00 in damages. (Pl.Ex. 21). Only part of NEP's damage claim was directly attributable to the cost of repairing the vessel. For example, only approximately 8 million dollars of NEP's damage claim was for the costs NEP incurred in arranging for steel renewals to the vessel.*fn2 (Id.).

NEP brought its damage claims before the same arbitration panel that had handled the parties' prior dispute. At this hearing, NEP argued that defendants had breached clauses 3 and 6 of the charter agreement, requiring defendants to perform diligent maintenance on the vessel, and to keep the vessel "in class" and "in good repair" during the period of the charter. (Jt. Or. at 54; Jt. Ex. 232). The arbitration hearing was held over twenty-six days, and the panel ultimately decided that defendants could be held liable for the damage to the vessel under clauses 3 and 6 of the charter agreement.*fn3 (Jt. Or. at 54, ¶¶ 21-24). Defendants and NEP then entered a settlement agreement, dated August 29, 1997, in which defendants agreed to settle all of NEP's remaining damage claims for $3,250,000.00 (Jt. Ex. 248).

Sedgwick subsequently notified plaintiffs that defendants intended to file a claim to cover the costs of its settlement with NEP for the vessel's damages under a bumbershoot policy plaintiffs had issued to defendants for the period May 11, 1995, to May 1, 1996. Specifically, defendants requested indemnification for: $3,250,000.00 in damages and $2,000,000.00 in punitive damages paid to NEP in the settlement; $350,120.00 NEP collected as interest on the settlement; $1,891,800.92 in lawyers' fees incurred while opposing NEP's claims; $479,174.64 in costs and expenses incurred in the arbitration; and interest at prime rate plus 3% on the claim settled with NEP as of the date the settlement was made.

B. The Policy

The bumbershoot policy at issue is a standard marine umbrella insurance policy; it provides both excess insurance coverage and "drop down" coverage.*fn4 (Tr. at 18, 27). The excess insurance provisions provide insurance coverage over and above the limits of the assureds' enumerated primary insurance policies, and only respond when the limits of the primary policies have been exhausted. See Raymond P. Hayden & Sanford E. Balick, Marine Insurance: Varieties, Combinations and Coverages, 66 Tul.L.Rev. 311, 353 (1991) ("Marine Insurance"). The "drop down" provisions of the policy fill in gaps in coverage left by the primary insurances. See id. at 361; (Tr. at 27). The dispute in this case concerns the scope of the bumbershoot policy's drop down provisions.

Defendants purchased their bumbershoot policy through Sedgwick. Negotiations on the policy began when Joseph Morency, the Assistant Vice President and Marine Underwriters Liability Manager for Reliance, advised Sedgwick Assistant Vice President Elizabeth Gallagher, that defendants' current bumbershoot policy was about to expire. Morency indicated that Reliance was interested in participating in a joint subscription with other insurers for defendants' bumbershoot coverage for the year 1995-1996, contingent upon its approval of defendants' insurance renewal application ("application") (Tr. at 52-53).

Gallagher prepared the application, which required detailed information regarding defendants' potential liabilities, and their primary insurance coverage for the 1995-1996 calendar year. On page 00006 of the application, in response to the question "Describe contractual coverage in primary policy[s]," Gallagher indicated:

"Lease agreements covered by primary CGL.*fn5 Charter Parties/Labor Agreements/Operating Agreements covered by P & I policy. Storage/Transfer Agreements covered by Terminal Operators Liability Policy." (Jt. Ex. 223 emphasis added).

The P & I policy Gallagher referred to in the application was a protection and indemnity ("P & I") policy that another insurer, American Club, had issued to Keystone. Gallagher also indicated in the application that the American Club P & I policy offered defendants unlimited P & I coverage, except for a $500,000,000 pollution limitation. (Id.; Tr. at 55). Gallagher testified that she was at Keystone's offices when she prepared the application and could have examined the American Club P & I policy and the charter agreement, but she failed to do so. (Tr. at 48485). Gallagher further testified that her statement in the application, that defendants' charter agreement liability was covered under the American Club P & I policy, was only intended to indicate that this insurance would cover some charter agreement liabilities. (Tr. at 483).

Morency testified at trial that he reviewed the application and, based on Gallagher's responses, agreed that Reliance would issue defendants bumbershoot coverage from May 11, 1995, to May 1, 1996. (Tr. at 55-56). Morency also testified that, since he assumed that defendants had unlimited P & I coverage for the charter agreement, he calculated their premium for the bumbershoot policy using a percentage of the standard premiums for Terminal Operators, Contingent Marine Liability, Comprehensive General Liability and Automobile policies. (Id. at 57-58).

Sedgwick was responsible for preparing the final policy, which was a series of boilerplate excess multi-liability insurance forms with standard bumbershoot clauses. (Tr. at 20-21). The parties had no further communication about the bumbershoot policy's scope until April 1996, when plaintiffs received a letter from Sedgwick indicating that defendants would seek indemnification under the bumbershoot policy for the costs of repairing the vessel's damage and other costs from the settlement with NEP. (Pl. Ex. 20).

C. Claims Process Facts

At the start of the dispute with NEP about the vessel's damage, defendants assigned Achuff to investigate which of their insurance policies would indemnify them for the potential liability arising from this matter. Achuff had Sedgwick employees send letters to several of defendants' insurers which summarized NEP's allegations that defendants' deficient maintenance had severely damaged the vessel during the charter term. (See, e.g., Pl.Ex. 21) ("Sedgwick claim letters"). Before sending out the claim letters, Achuff discussed NEP's allegations with Ralph Hill, Keystone's general counsel, and other Keystone officials. Although the parties considered several causes for the vessel's wastage, no one indicated, as later alleged, that microbes had damaged the ship.

In response to a Sedgwick claim letter, American Club sent Sedgwick a letter, dated May 30, 1996, denying defendants coverage under defendants' primary P & I policy. (Jt. Ex. 243). American Club indicated that the dispute about the vessel's damage concerned wear and tear damage to the assureds' own property, and therefore was not covered under the terms of their P & I policy. (Id).

American Hull Insurance Syndicate ("AHIS"), the underwriter of defendants' primary hull policy, also responded to the Sedgwick claim letter by denying defendants coverage. AHIS explained that the costs from the dispute about the vessel's damage "did not arise from losses sustained as the owner of the vessel, but rather [were being made] on the basis of [defendants'] contractual indemnity to NEP[]," and therefore defendants should look to their third party liability policies to cover these losses. (Jt. Ex. 246).

Plaintiffs also responded to the Sedgwick claim letter by denying defendants coverage. In a letter, dated July 23, 1996, plaintiffs indicated that the dispute about the vessel's damage was not covered under the bumbershoot policy because: (1) the damage to the vessel was a result of ordinary wear and tear, and therefore was not an "occurrence" covered by P & I insurance, and (2) the damage to the vessel occurred while defendants still owned the vessel, and therefore did not constitute third party liability. (Jt. Ex. 240). Achuff discussed with Keystone officials the various letters from defendants' insurers denying defendants coverage. Although Keystone officials mentioned several possible causes for the vessel's damage, again, no one suggested that microbes had caused the damage. (Tr. at 354).

On August 12, 1996, Sedgwick and Reliance representatives convened to discuss whether Reliance, as lead underwriter, would extend coverage under the bumbershoot policy for the dispute about the vessel's damage. During the meeting, Reliance and Sedgwick representatives discussed the damage to the vessel as though it had resulted from ordinary wear and tear; no mention was made of damage-causing microbes. (Tr. at 114-16, 367-69).

After the meeting Sedgwick crafted a response to Reliance's denial of defendants' claim. In a letter, dated August 13, 1996, Sedgwick explained that the vessel's damage was caused by repeated exposure to environmental conditions which triggered oxidation and corrosion of the vessel's steel holds. (Pl.Ex. 39). Achuff reviewed this letter with Keystone's general counsel and other Keystone and IBC officers, and the letter was approved. (Tr. at 365-66). None of these officers indicated at this time that the vessel's damage was caused by microbes.

Reliance again indicated to defendants that it did not believe that the bumbershoot policy offered coverage for the vessel's damage or the NEP settlement; defendants continued to assert that the policy did cover these costs. Reliance ultimately convened with the other underwriters who had subscribed to the bumbershoot policy and with counsel, and as a group denied defendants coverage under the policy. (Tr. at 31-32). Additionally, the underwriters brought the instant claim under 28 U.S.C. § 1333 and § 2201 for a declaratory ...

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