In order to keep you abreast of recent developments in the law, Saunders & Schmieler’s S&S Recent Developments in the Law reports on the significance of current decisions of major import in the jurisdictions of Maryland, the District of Columbia, Virginia, and the federal Fourth Circuit.

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Recent Developments

in the Law

Jeffrey R. Schmieler, Esquire

Alan B. Neurick, Esquire

Lucas F. Webster, Esquire

Saunders & Schmieler, P.C.

8737 Colesville Road

Suite L-200

Silver Spring, Maryland 20910

(301) 588-7717

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© Saunders & Schmieler, P.C. 2002

MARYLAND COURT OF SPECIAL APPEALS

Court of Special Appeals of Maryland Holds There is No Duty to Defend Nor Indemnify Bethesda Airport Security Contractor for Violations of the False Claims Act.

Information Systems and Network Corporation v. Federal Insurance Company,  No. 1874 (Md. App. June 24, 2002).

On June 24, 2002, Judge Theodore G. Bloom, specially assigned, of the Court of Special Appeals, vacated the ruling of Judge Martha G. Kavanaugh of the Circuit Court of Montgomery County on technical grounds, yet affirmed the  denial of insurance coverage to Information Systems and Network Corporation (“ISN”) by Federal Insurance Company (“Federal”).  The trial court, in a case of first impression in the state, found that Federal was not required to defend nor indemnify ISN in its defense of a qui tam False Claims Acts action.  The Maryland Court of Special Appeals, however, vacated the holding and remanded, since an entry of summary judgment was entered when a declaratory judgment in favor of Federal was the proper result.  Nevertheless, the appellate court upheld the substance of the trial court,  holding that ISN’s insurance  policy did not provide either a defense or indemnification for a qui tam action.

The Plaintiffs/Appellants, ISN, of Bethesda, Maryland,  and  the Port of Oakland, California, sought a declaratory judgment that Federal was obligated, pursuant to the Federal Commercial General Liability (“CGL”) and Commercial Excess Umbrella policies issued to defend and indemnify ISN for an underlying qui tam False Claims Acts suit.  The underlying qui tam action was filed against ISN in California, for which ISN and the Port sought $1,322,726 in indemnification plus substantial attorney’s fees. Federal was represented by Saunders & Schmieler, P.C., Jeffrey R. Schmieler, Esq. in the motions and at oral argument, and by Lucas F. Webster, Esq. and Alan B. Neurick, Esq. in the motions. 

The lawsuit filed against ISN was a qui tam action.  The idiom qui tam  comes from a Latin phrase meaning “one who sues on behalf of the King  as well as for himself.”  Today,  a qui tam action is defined as one brought under a statute that allows a private person to sue for a penalty, part of which the government or some specified public institution will receive.  Securacom, Inc. filed the qui tam action in the United District Court for the Northern District of California on behalf of itself, the United States, and the State of California.  Securacom alleged that ISN, ISN’s president and chief executive officer, and one of ISN’s vice presidents, had fraudulently and knowingly submitted false claims to the Board of Port Commissioners of the City of Oakland, California (the Port) in violation of 31 U.S.C. §3729 et seq., the False Claims Act,  and Cal. Govt. Code §12650 et seq. (the False Claims Acts).  The purpose of the False Claims Act is "to protect funds and property of the government from fraudulent claims.”  The False Claims Act is violated when a person or entity knowingly and purposefully deceives the Government in order to improperly obtain money from, or improperly be relieved from paying money to, the public fisc.

The alleged false claims related to a contractor’s bid and to work ISN performed at the Oakland International Airport.  In October 1991, ISN was the low bidder for a contract to provide a new automated access control system to be installed at the airport.  In the qui tam suit, Securacom, the next lowest bidder, alleged that ISN knowingly and fraudulently concealed material information and affirmatively misrepresented facts to the Port to induce the Port to award the contract to it.  Securacom alleged that ISN falsely represented that it had the knowledge, experience, qualifications, and ability to do the job it bid for, and committed other misrepresentations and deceptions regarding, among other things, its contractor’s license and problems with the security system product that ISN had experienced in two previous airport projects.  The damages sought by Securacom and the Port in the qui tam suit included delay damages, loss of use of the security system, the need for repair or replacement of the security systems, and treble damages as authorized by the False Claims Acts.

Although they had the opportunity to intervene in the qui tam suit, the United States and the State of California declined to do so.  The Port of Oakland, however, intervened, claiming that ISN had knowledge that a key component of the security system was defective and concealed that fact.  The Port sought damages equal to the amount of the progress payments made to ISN in response to the false claims, treble damages, a civil penalty of $10,000 for each of the five false claims alleged, and costs of the suit.  ISN and the Port settled the Port’s claim for $1,322,726 in actual damages and $75,000 in attorney’s fees.  Pursuant to the terms of the settlement agreement, ISN assigned to the Port its rights under certain insurance policies with respect to the claim, to the extent necessary to secure payment of the judgment.  The Port agreed to cooperate with ISN in a direct action against ISN’s insurer, Federal, to collect the balance of the judgment.

ISN and the Port filed a lawsuit in the Circuit Court for Montgomery County against Federal and The Chubb Group of Insurance Companies (Chubb).  The claims against Chubb were eventually dismissed.  ISN and the Port pursued a declaratory judgment that Federal was obligated, pursuant to the CGL and Commercial Excess Umbrella policies, to defend and indemnify ISN in the qui tam action.  ISN also sought damages for breach of contract arising out of Federal’s failure to defend and indemnify it in the qui tam action.

Both parties filed motions for summary judgment.  ISN’s motion asserted that it was entitled, as a matter of law, to a declaratory judgment that the insurance policies provided coverage for the defense and indemnity of ISN with respect to the qui tam action.  At oral argument, Jeffrey R. Schmieler, esq., on behalf of Federal, argued that ISN’s claims did not constitute “property damages caused by an occurrence” as required by the provisions of both the CGL and the Commercial Excess Umbrella policies. Also, Federal argued that the qui tam action was predicated upon the fact that ISN knowingly and fraudulently defrauded a government entity and the public fisc, and thus was not entitled to insurance coverage for public policy reasons.

The trial court granted Federal’s motion for summary judgment.   The court concluded that the subject insurance policies provide coverage only for “property damage caused by an occurrence,” and that none of those elements were present in the qui tam action. And, the court determined that the complaint filed in the qui tam action contained allegations that ISN had submitted false and fraudulent claims to the Port, and that it involved “fraud perpetrated on a government entity,” and thus was not entitled to indemnification or a defense from Federal.

ISN appealed to the Court of Special Appeals.  Appellate arguments were held onMay 4, 2001, withJeffrey R. Schmieler, esq. again arguing on behalf of Federal.  Judge Bloom of the Court of Special Appeals began his opinion with a discussion of the duty to defend and the duty to indemnify in Maryland.  Quoting at length from Mesmer v. Maryland Auto Ins. Fund, 353 Md. 241 (1999), the court reiterated the Maryland law  that under the typical liability insurance policy, the insurer has a duty to indemnify the insured only up to the limits of the policy, based on a liability claim which is covered.  The insurer also has a duty to defend the insured against a liability claim which is covered or which is potentially covered.  If a tort plaintiff does not allege facts which clearly bring the claim within or without the policy coverage, the insurer still must defend if there is a potentiality that the claim could be covered by the policy.  Essentially, the source of both duties is solely the insurance contract.

Moreover, the court looked for guidance at St.Paul Fire & Marine Ins. Co. v. Pryseski, 292 Md. 187 (1981), which articulated a two-part inquiry to be used to ascertain when an insurer is under a duty to defend an insured.  The first question considers what is the coverage, and what are the defenses under the terms and requirements of the insurance policy.  Second, the court must address whether the allegations in the tort action potentially bring the tort claim within the policy’s coverage.  The first question focuses upon the language and requirements of the policy, and the second question focuses upon the allegations of the tort suit and the ultimate liability imposed.  And throughout this inquiry, the standard of interpretation is to give the words their customary, ordinary, and accepted meaning. 

The court then turned to the provisions in the insurance contracts at issue.  Both of the Federal CGL and Umbrella policies contained language which provided coverage for “bodily injury or property damage caused by an occurrence.”  “Property damage” is defined in the policies as “1. physical injury to tangible property including all resulting loss of use of that property; or 2. loss of use of tangible property that is not physically injured.”  Based on this language, therefore, the court determined that the settlement between ISN and the Port was not for “property damage” in any sense  of the insurance policy.  The court agreed with Federal that the Port had only sought damages resulting from the allegation that ISN had knowingly provided false, misleading, and fraudulent information in order to obtain the contract. Further, that the Port had not complained of any damages to its property.  Rather, it only sought damages for the costs of the forfeiture of the security system, the money it had paid to ISN under the falsely obtained contract, delay damages, and statutory penalties.  Thus the Port’s underlying basis for the damages and penalties sought was ISN’s knowing and fraudulent presentation of false claims to the Port, not for damages to wires and failed component parts of the security system. Consequently, under its policies, Federal had no duty to the defend the qui tam action and had no obligation to indemnify ISN or its assignee, the Port. 

The court also considered relevant exclusions in the CGL policy that pertain to damage to the property of others.  It found that the insurance does not apply to damage to the property of others or property that must be restored, repaired or replaced because work was incorrectly performed on it.  Also, the insurance policy further excluded coverage for property damaged from use by persons because of known defects, deficiencies, or dangerous conditions.  The Court of Special Appeals thus found no error in Judge Kavanaugh’s conclusion that “contractual nonperformance does not equate to property damage, as that term is defined in the policy.” The exclusions made clear that there is no coverage for any of the claims made in the qui tam action.

Thus the court concluded that without express language in the insurance contract agreeing to defend and indemnify its insured in a qui tam action, the insurer was not obligated to defend or indemnify  absent actual property damage.  The Port had argued that the loss of the use of the security system and the need to replace it constituted a loss of the use of property, which would amount to property damage.  The court flatly rejected these contentions.  Judge Bloom found no error in the circuit court’s conclusion that a claim of contractual nonperformance did not equate to property damage, as that term is defined in the policies.  The court nevertheless was compelled to vacate the grant of summary judgment and remand, for in an action seeking a declaratory judgment, summary judgment is improper.  Although the rationale behind both the trial and appellate orders are very similar, the terms of the declaratory judgment must be set forth separately.  That is, when entering a declaratory judgment, the court must state its declaration of the rights of the parties.  This serves to give the parties and the public fair notice of what the court has determined.

This action of first impression in Maryland is an important one, in that it addressed the novel issue of whether insurance carriers have the duty to defend or indemnify its insured when the insured is sued under the Federal or a state False Claims Act.  The decision transcends the legal realm, in that it extends broadly across a variety of business and governmental entities affecting each of their interests in a fundamental manner.  The decision may cause businesses to re-examine past, present, and future dealings with governmental agencies.  The False Claims Acts, essentially whistle-blower statutes, may cause companies to come forward voluntarily to resolve any past misdeeds before they become subject to a liability suit.  Also, since government contractors abound in the Maryland-D.C.-Virginia area, businesses with relationships to federal government agencies may benefit from the rule of law established in this case.  Companies which defraud the government will be required to remedy such wrongful conduct themselves, and will not be able to shift that consequence to a third party, such as their liability insurance carrier.

For full text of the above opinion, e-mail schmielerj@sslawfirm.com