New Jersey Supreme Court warns insurers against seeking declaratory relief while defending the polic

Citing New Jersey’s interest in remediating contaminated sites within its borders, the New Jersey Supreme Court has held that a later-filed New Jersey coverage suit takes precedence over an earlier-filed lawsuit in New York.  The Supreme Court’s ruling could be viewed as the latest affirmance of New Jersey’s longstanding interest in funding remediation projects in New Jersey, except that the court offered a second, and novel, basis for its holding – that the primary insurer defending the policyholder under a reservation of rights acted cavalierly, and perhaps in bad faith, by initiating a declaratory action to determine coverage.  The court’s criticism of insurer initiated coverage suits contradicts longstanding practice and creates uncertainty for insurers seeking a judicial resolution of coverage issues. 

In Sensient Colors, Inc. v. Allstate Insurance Company, et al., decided January 29, 2008, the New Jersey Supreme Court held that a later-filed declaratory action brought by the policyholder in an environmental coverage dispute would not be dismissed in favor of a first-filed action in New York because “special equities” favored litigation in New Jersey. 

Sensient Colors manufactured colorants and organic pigments at a factory in Camden, New Jersey, from 1922 to 1988.  By 1998 the factory site was abandoned, and leaking drums containing hazardous chemicals were found at the site.  The U.S. Environmental Protection Agency, with local and state agencies, removed thousands of drums and containers of hazardous substances from the site over the next several years. The EPA demanded that Sensient reimburse it more than $10 million for remediation expenses. 

Sensient notified its liability insurers, including Zurich Insurance Company, of the EPA reimbursement demand.  Zurich agreed to participate in the defense of Sensient in connection with the EPA demand and a related lawsuit under a reservation of rights.  Other notified insurers refused to defend Sensient.  Less than a year later, Zurich brought a declaratory action in New York seeking a determination that it had no obligation to continue to defend Sensient or to indemnify it for the EPA demand and the related lawsuit.  Two months later, Sensient brought a near identical declaratory suit in New Jersey. 

 
Zurich moved to dismiss the New Jersey declaratory action based on the “first-filed rule,” a rule of comity providing that the court that first acquires jurisdiction generally has precedence.  The trial court dismissed the later-filed New Jersey action based on the first-filed rule.  The New Jersey Superior Court, Appellate Division reversed, holding that special equities justified New Jersey’s retention of the litigation, in particular the significant New Jersey interest in remediating a contaminated New Jersey site and the related interests of ensuring that coverage was available to fund/reimburse that remediation. 

The Supreme Court agreed that special equities warranted retention of the coverage action in New Jersey., explaining that the special equities justifying its holding were New Jersey’s strong interest in remediating contaminated sites and the “preemptive” filing of a coverage suit in New York. 

The Supreme Court’s decision includes strong criticism of the insurer’s decision to file a declaratory action and suggests that Zurich acted in bad faith when defending its policyholder under a reservation of rights and then seeking a coverage determination by bringing a declaratory suit.  The court stated that Zurich “informed Sensient that it would participate in the defense [of the underlying claims] under a reservation of rights.”  The court noted that “without in any way signaling to Sensient that it had changed its mind and decided to deny coverage,” Zurich filed a declaratory action.  Characterizing the suit as a “preemptive move” made “without warning,” the court found that the special equities justifying New Jersey exercising jurisdiction over the later-filed coverage suit included that “Zurich engaged in a first-strike maneuver, filing suit in New York while a lulled Sensient sat on its rights.”

Before the holding in Sensient Colors, New Jersey courts encouraged insurers to protect themselves by filing a declaratory judgment action to resolve coverage issues.  The court in L.C.S., Inc. v. Lexington Ins. Co., 371 N.J. Super. 482, 853 A. 2 974 (App. Div. 2004) made clear that an insurer defending its policyholder under a reservation of rights can “protect itself” by:

  • …filing a separate declaratory judgment action, thereby preserving its right to subsequently withdraw from the defense if discovery reveals the applicability of the exclusion.  [371 N.J. Super. at 493, 853 A. 2 at 981].

 

The court in Sensient Colors made no reference to the L.C.S. decision and offered no guidance to insurers when seeking judicial resolution of coverage issues. 

Coverage counsel for Sensient Colors seized on the Supreme Court’s criticism, proclaiming that “if nothing else, this will cause insurance companies to think twice before suing their insured.”  “New Jersey Courts Have Preference In Suits Over Toxic-Site Cleanup,” New Jersey Law Journal, February 4, 2008.  It remains to be seen whether this aspect of the court’s holding in Sensient Colors is confined to the facts of the case or is applied more broadly to discourage insurers from bringing coverage suits.  Until this important issue of New Jersey coverage law is clarified, insurers should think twice when drafting reservation of rights letters and consider specifically reserving the insurer’s right to initiate a declaratory action and inserting language unequivocally advising the policyholder that coverage is disputed and may be resolved through a declaratory action.

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