Court Stays Litigation of Certain Coverage Defenses, Allows Others To Proceed Pending Resolution of Underlying Litigation

Applying California law, the United States District Court for the Northern District of California has granted an insured’s motion to stay in part, holding that certain of an insurer’s coverage defenses should be stayed pending resolution of underlying litigation where those coverage defenses turn on facts to be litigated in the underlying litigation. Ironshore Spec. Ins. Co. v. 23andMe, Inc., 2015 WL 2265900 (N.D. Cal. May 14, 2015). The court denied the insured’s motion to stay with respect to the applicability of the policy’s contract exclusion, finding that the issue could be decided based upon the underlying pleadings and was not controlled by the determination of fact issues in the underlying litigation.

The insured sold DNA saliva kits that allegedly allowed consumers to access and understand their personal genetic information. The Food and Drug Administration (FDA) issued a warning letter concerning certain aspects of the DNA kits, alleging the kits were sold without approval. Subsequently, several putative class action complaints and an arbitration demand were filed against the insured in connection with the sale of the DNA kits, which generally alleged false and misleading advertising, unfair competition and violation of consumer protection law claims. The State of Washington also initiated an investigation into the insured’s DNA kits.

The insured tendered the class action complaints, arbitration demand and the state investigation under its professional liability and life sciences policy. The insurer agreed to defend the actions under a reservation of rights and filed a declaratory judgment action seeking a declaration that it does not have a duty to defend or indemnify the insured based on several different coverage defenses, including that the (i) claims did not seek covered or insurable “Damages”; (ii) the off-label promotion exclusion barred coverage; (iii) the claims do not allege a “Wrongful Act”; and (iv) the contractual liability exclusion barred coverage, which precludes coverage for claims arising from the insured’s “assumption of liability or obligations in a contract or agreement.” The insured filed a motion to stay the coverage litigation pending resolution of the underlying claims.

The court granted in part and denied in part the insured’s motion to stay. In so doing, the court examined the relevant issues under California law in determining whether it is appropriate to stay an insurer’s declaratory judgment action as set forth in Montrose Chemical Corp. of California v. Superior Court, 6 Cal. 4th 287 (1993) (Montrose I) and Montrose Chemical Corp. of California v. Superior Court, 25 Cal. App. 4th 902 (1994) (Montrose II). The court noted that Montrose I held that “a stay of the declaratory relief action pending resolution of the third party suit is appropriate when the coverage question turns on facts to be litigated in the underlying action.” The court further stated that Montrose II recognized that there are “three ways in which an insured might be prejudiced by concurrent litigation of the declaratory relief and third party actions: (1) the insurer might ‘join forces with the plaintiffs in the underlying actions as a means to defeat coverage’; (2) the insured might be ‘compelled to fight a two-front war, doing battle with the plaintiffs in the third party litigation while at the same time devoting its money and its human resources to litigating coverage issues with its carriers’; and (3) ‘the insured may be collaterally estopped from relitigating any adverse factual findings in the third party action, notwithstanding that any fact found in the insured’s favor could not be used to its advantage.’”  According to the court, “[a] stay is required in the first and third type of prejudice involving factual overlap”; otherwise, the issue is left to the discretion of the court.

Here, the court addressed each coverage defense, applying the factors set out in Montrose I and Montrose II. With respect to the insurer’s argument that the claims alleged uncovered or uninsurable “Damages,” the court held that whether the claims seek equitable relief or restitution, which are excepted from the definition of “Damages,” or amounts not insurable under California law “is not apparent on the face of the underlying pleadings.” In this regard, the court stated that “any determination by this Court that [the insured’s] revenues from the [DNA kits] were ill-gotten or wrongfully acquired would be precisely the type of adjudication prohibited by Montrose II.” The court similarly concluded that whether coverage is barred by the off-label promotion exclusion in the policy, which bars coverage for claims arising out of the “promotion of off-label or unapproved uses for drugs or medical devices,” “cannot be litigated without determining factual issues that overlap with the underlying litigation . . . [because] the Court would have to make a factual determination that [the insured] promoted ‘off-label or unapproved uses for drugs or medical devices” . . . , and then would have to conclude that the underlying claims are based upon that promotion.” Concerning the insurer’s defense that the claims alleged intentional or reckless conduct that did not constitute a “Wrongful Act,” the court held that because “[n]one of the underlying actions are limited solely to the claims identified by [the insurer] as barred by the definition of ‘Wrongful Act,’ . . . [and the] adjudication of the ‘Wrongful Act defense would not relieve [the insurer] of its duty to defend the underlying actions,” the burden to the insured to litigate nondispositive issues outweighs the insurer’s interests. The court thus granted the insured’s motion to stay in part.

The court, however, denied the insured’s motion to stay with respect to the insurer’s defense that coverage was barred in its entirety by the policy’s contractual liability exclusion. The insurer contended that because each claimant entered into a contract with the insured when purchasing its DNA kit coverage was barred in its entirety for all claims. The court stated that it “need not determine the merits of the defense but only whether it can be litigated at this time without prejudice to [the insured]” and that the issue under the contract exclusion turns on “whether the underlying claims arise out of [the insured’s] ‘assumption of liability or obligations’ under those contracts.” The court held that “those issues can be resolved as a matter of law based upon the face of the underlying pleadings without determining factual issues that could give rise to collateral estoppel against [the insured] in the underlying actions.” The court further ruled that, “[i]n balancing the prejudice to [the insured] if the Contract exclusion defense is litigated at this time against the prejudice to [the insurer] if litigation of that defense is stayed, the Court has concluded that [the insurer’s] significant expenditure of resources defending [the insured] in actions as to which there may be no coverage outweighs the burden to [the insured] of litigating the Contract exclusion defense in the limited manner suggested by [the insurer].”