Third Circuit to the Rescue: Court Orders Safeguards for Business Secrets Disclosed by Litigants Flouting Protective Orders
Pennsylvania Superior Court Gives Sureties Another Tool in the Toolbox
Third Circuit Addresses the Scope of the Duty To Defend Under Pennsylvania Law in Recent Advertising Injury Dispute
Ninth Circuit Finds Social Engineering Fraud Covered by Commercial Crime Policy
Court News

Third Circuit to the Rescue: Court Orders Safeguards for Business Secrets Disclosed by Litigants Flouting Protective Orders 

One of a business executive’s worst fears is the public disclosure of the company’s competitive information. Enterprises invest money, time, and energy to develop better product and service offerings for their customers at better prices. Businesses keep their processes and methods under tight wraps to keep their marketplace edge. So when trade secrets are leaked to the public (and, by extension, the competition), the result can be devastating. A company’s competitors get an easy look behind the curtain and can copy the company’s methods and undercut its pricing – all without having to spend a penny.

This bad dream became a waking nightmare for a health insurance company in Federal Trade Commission v. Thomas Jefferson University.¹ There, the FTC challenged the merger of two hospital systems as anti-competitive in federal court. The FTC subpoenaed the health insurer as part of its investigation and litigation efforts, and the insurer had to turn over many confidential documents. This included materials revealing sensitive business plans, negotiating strategies, reimbursement rates, bidding information, pricing data, contracting information, and strategic planning and analysis material. To protect itself, the insurer ensured a confidentiality agreement covered these documents. Under that arrangement, the lawsuit’s parties had to notify the insurer if they planned to publicly file any confidential materials. That way, the insurer could move to seal the materials from public disclosure.

During earlier stages in the case, the litigants honored this agreement. As a result, some of the insurer’s documents were filed under seal. Later, the parties decided to use more of the insurer’s sensitive documents. But this time, “for unexplained reasons,” nobody told the insurer! The litigants simply plowed ahead – in seeming violation of the protective order – and the court wound up entering six of the insurer’s secret documents into evidence. Sensitive competitive information thus was widely available for perusal and copying by the insurer’s competitors. The toothpaste was out of the tube. The cat was out of the bag. Even worse, the public filing turned the documents into “judicial records,” triggering a strong presumption favoring public access.

The insurer eventually found out what the parties had done. In a panic, it immediately “scrambled” to file a motion to seal. Despite its haste, the insurer mustered: a declaration describing how disclosure would harm it competitively; a chart showing the types of business information in the filed documents; redacted versions of these sensitive documents; and a request for a hearing if the court needed more evidence or argument.

But then the FTC and hospital systems settled, and the district court dismissed the case. That in turn led the court to wave away the insurer’s motion to seal, denying it in a short footnote in a “housekeeping order.” There, the court summarily decided the insurer had not adequately explained and supported its claim of competitive harm. The court thus never weighed the insurer’s competitive interest in each document against the public’s right of access.

The health insurer promptly appealed to the U.S. Court of Appeals for the Third Circuit, which gave the insurer some needed relief. In a decision by Judge Thomas Ambro, the court explained that the “unusual circumstances” meant the insurer “was due a full opportunity to argue its motion.” It deserved “the opportunity to make [its] explanation and present evidence at a hearing.” This, even though the insurer’s motion and declaration purportedly “lacked some precision.” The court excused this because the insurer was “forced to file a rushed motion after several unexplained foot faults by the parties.” And the circuit court found the district court also had to hold a hearing because it faulted the insurer for failing to explain its claims and support them with evidence. The Third Circuit thus vacated the district court’s order and sent the matter back for the district court to hold a hearing.

In a concurrence, Judge Marjorie Rendell pointed out that the central problem with the district court’s decision was its lack of analysis. She explained that a motion to seal requires a district court to carefully review each document, weigh the relevant factors, and explain its decision in detail. Only by doing so can a district court facilitate appellate review. As Judge Rendell explained, the “lack of explicit analysis” required a remand.

Businesses should take heart in the Third Circuit’s Federal Trade Commission v. Thomas Jefferson University decision. It shows the appellate court will guard against flippant responses to claims that sensitive competitive information should not be publicly disclosed on a court docket. The circuit court will require district courts to afford third parties full and fair consideration when they seek to protect confidential information they have no choice but to disclose in response to a subpoena. What’s more, a settlement between others does not affect the rights of a third party seeking to protect its information. The court’s decision rightly recognizes that an enterprise’s proprietary interest in protecting its secrets has no relationship to the settlement of others’ disputes. The Third Circuit requires respectful treatment of business secrets regardless of such developments.

¹ No. 21-1817, 2022 WL 473024 (3d Cir. Feb. 16, 2022).

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Pennsylvania Superior Court Gives Sureties Another Tool in the Toolbox 

Assignment rights historically have served as a useful device for sureties seeking to recoup payments they have made on their bonds. Indeed, sureties’ standard indemnity agreements normally require the bond principal – the surety’s customer – to assign the surety the right to repayment in some cases. And sureties also typically ask claimants paid pursuant to surety bonds to sign similar assignments, thus enabling the surety to recover from the principal payments they have made to the claimant.

But what happens when the principal on an appeal bond (also known as supersedeas bond) has suffered a judgment? Is it too late for an assignment? The Pennsylvania Superior Court recently answered “no” in a case in which Stradley Ronon represented the surety.

The story in Crespo v. Hughes¹ began when a worker suffered chemical burns to his hands. He rushed to the emergency room for treatment, but the ER doctor’s treatment allegedly failed, causing the plaintiff to lose part of a finger. He sued the doctor for malpractice, and a jury awarded damages. The doctor appealed, and his insurer bought an appeal (or supersedeas) bond to keep the plaintiff from executing on the judgment while he appealed. The Superior Court later affirmed the judgment against the doctor.

The surety paid the judgment, as required by the appeal bond, but also approached the plaintiff to obtain an assignment so that it could recoup that money from the doctor. The plaintiff agreed, thus transferring to the surety sole rights to the judgment against the doctor. The surety then moved to enforce the judgment, including by seeking to attach assets.

The doctor – the bond principal – fought back against the surety’s attempt to enforce. He argued the surety’s payment of the judgment (the very subject of the appeal bond) meant the surety had actually satisfied that judgment. Put another way, the doctor argued the surety’s payment meant there was nothing left for the plaintiff to assign to the surety.

The Superior Court ruled in favor of the surety. It explained that “payment by a third party of a debtor’s obligation is not a discharge of the debt, but a purchase of it.” It also reasoned that the “intentions of the parties” govern; here, the assignment did not reflect any intent to satisfy the judgment. The court similarly rejected the doctor’s contention that the assignment lacked consideration, pointing out that consideration is not needed when the agreement includes “an express statement” that “the signer intends to be legally bound.” Lastly, the court rejected the doctor’s contention that a lack of privity between the doctor and surety mattered, pointing out that “privity is not an issue in cases involving assignment claims.”

Distilled to its essence, the Superior Court’s Crespo holding is that a surety can simultaneously satisfy its bond obligations by making a payment to the claimant and acquire by assignment the claimant’s judgment against the bond principal. Given the court’s reasoning, sureties should craft their assignments with precision. They should include language stating that the claimant intends to be legally bound and clarifying that the parties’ intent is solely to assign the claimant’s rights – not satisfy the judgment. Assuming sureties carefully draft their assignments, Crespo shows that, even at the judgment stage, it is not too late to use an assignment to mitigate a surety’s loss.

¹ No. 2184 EDA 2020, 2021 WL 5858464 (Pa. Super. Dec. 10, 2021).

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What We’re Watching: Two Recent Insurance Appellate Decisions 

Third Circuit Addresses the Scope of the Duty To Defend Under Pennsylvania Law in Recent Advertising Injury Dispute

In its recent decision in Vitamin Energy v. Evanston Insurance Company,¹ the U.S. Court of Appeals for the Third Circuit addressed the scope of Pennsylvania’s duty to defend in the context of an alleged advertising injury.

The owners of the 5-Hour Energy brand of liquid energy shots sued Vitamin Energy. 5-Hour alleged that Vitamin infringed its trademark and alleged additional causes of action for false designation of origin, false advertising, and trademark dilution, along with Michigan state law claims of direct and indirect trademark infringement and unfair competition. Among the claims was 5-Hour’s charge that Vitamin had engaged in “false and misleading comparative advertising” with 5-Hour’s energy shots. These claims became the cornerstone of the Third Circuit’s reversal of the district court’s ruling.

Vitamin’s insurance policy with Evanston Insurance Company stated that Evanston had to defend Vitamin against claims of an Advertising Injury. But Evanston said that the 5-Hour Energy claims did not allege an Advertising Injury and that, if they did, coverage exclusions still applied to remove any coverage obligation. The Third Circuit disagreed.

First, the court noted that Pennsylvania has a broad duty to defend, and that if any claim in the complaint actually or potentially fell within the scope of the policy, the insurer needed to defend the entire action until all that remained was patently outside of policy coverage. The court also explained that the Evanston policy generally defined an Advertising Injury as an injury arising out of any oral or written publication of material that libels or slanders an organization’s products or goods. The court pointed out that Evanston and Vitamin had agreed in their briefing that disparaging material as covered by the policy would include, at a minimum, an injurious false statement about another’s goods.

In considering the details of the dispute, the court noted that the disagreement centered on whether 5-Hour’s claims alleged that Vitamin’s comparative advertising contained false or misleading statements about 5-Hour or only a falsehood about Vitamin’s own products. The court explained that, in determining whether the duty to defend is triggered under Pennsylvania law, the allegations must be liberally construed in favor of coverage.

With Pennsylvania’s duty to defend standard in mind – and reiterating that if even one allegation falls within the scope of coverage, the duty to defend the entire action is triggered – the Third Circuit held that the duty to defend was in fact triggered. This was because, despite the many complaint allegations over Vitamin’s allegedly false and misleading characterizations of its own products, there remained many allegations of false and misleading characterizations of 5-Hour’s products, with resulting injury alleged. And these latter allegations triggered the duty to defend the entire dispute.

The court then elaborated that its ruling that these allegations triggered Evanston’s duty to defend was based on the recognition that the duty to defend is broader than the duty to indemnify. The court took no position on whether 5-Hour’s claims might be meritorious, let alone whether it could prevail on them for indemnity purposes. The truth or merit of the allegations was not an issue when determining whether there was a duty to defend against those claims.

Next, the court addressed the exclusions in the policy, which Evanston said removed any potential coverage. The court found that they did not disarm Evanston’s duty to defend.

First, the court found the Intellectual Property exclusion offered no safe harbor to Evanston, given the broad duty to defend already explained by the court. Even if that exclusion excluded coverage for losses related to trademark infringement, the alleged wrong that Vitamin relied on to invoke the duty to defend was the comparative advertisement supposedly misrepresenting the content of 5-Hour’s products. Since the policy potentially covered at least that one claim, that triggered the duty to defend and Evanston was required to defend the entire suit, regardless of coverage defenses to other claims in the dispute.

Next, the court reviewed Evanston’s arguments that the Incorrect Designation and Failure to Conform exclusions barred coverage. Once again, these exclusions only operated to bar coverage for claims related to Vitamin’s own products – not claims raised by 5-Hour about disparagements and misrepresentations as for 5-Hour’s products.

Finally, the court addressed the Evanston policy’s two so-called “Knowing” exclusions, barring coverage for claims the insured knowingly violated and injured another’s rights or with knowledge of the subject claims’ falsity. But again, the court noted that while there may be many claims and that some may or may not ultimately be subject to indemnity, the duty to defend them all was triggered by the other claims of disparagement.

Based on these findings, the court vacated the order of dismissal and remanded the matter to the district court for further proceedings in accord with its opinion. The Third Circuit’s decision makes clear that the duty to defend under Pennsylvania law, broader than the duty to indemnify, must be determined by careful comparison of the allegations of alleged injury-causing wrongdoing to the correlative provisions of the subject insurance policy.

¹ No. 3461, 22 F.4th 386 (3d Cir. Jan. 5, 2022).
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Ninth Circuit Finds Social Engineering Fraud Covered by Commercial Crime Policy 

The U.S. Court of Appeals for the Ninth Circuit recently addressed whether a commercial crime policy provided coverage for a social engineering fraud. Coverage disputes for social engineering frauds, particularly under the Funds Transfer Fraud and Computer Fraud coverages commonly included in commercial crime policies, have garnered significant attention over the past several years as sophisticated computer criminals have caused companies and governmental organizations to transfer millions of dollars under false pretenses. Courts addressing such claims have reached varying results, with some concluding that there was coverage and others concluding that there was not.

Generally speaking, social engineering fraud occurs when an unknown third party fraudulently impersonates an employee, vendor, or customer of the insured. While social engineering fraud can take on many different forms, impostors commonly use fake email accounts that appear to be from a superior or a vendor to provide instructions to an employee of the insured to pay or transfer money from the insured’s account at a financial institution to an account controlled by the impostor.

In Ernst & Haas Management Co. v. Hiscox, Inc.,¹ the Ninth Circuit faced an appeal from a district court’s dismissal of a claim by Ernst involving a loss of $200,000. An impostor sent emails to an accounts payable clerk at Ernst that appeared to be from the clerk’s superior. The impostor’s email directed the clerk to make payments to a third-party entity. Believing the emails to have come from her superior, the clerk transferred a total of $200,000 to an account controlled by the impostor before she became suspicious when the impostor directed her to make a $470,000 transfer. At that point, the clerk notified her superior and the social engineering fraud was discovered.

The district court, interpreting the Computer Fraud and Funds Transfer Fraud provisions in Ernst’s commercial crime policy, found that neither policy provision covered Ernst’s loss. The court reached that conclusion after determining that the loss resulted from the Ernst employee initiating wires to make the payments – not from the fraudulent email directing her to do so. The Ninth Circuit disagreed based on decisions involving similar facts from the Sixth and Eleventh Circuits, and it remanded the suit back to the district court for further proceedings.

The Ninth Circuit concluded that the district court erred in three ways. First, the Ninth Circuit held that the court improperly analogized the Ernst loss to an embezzlement. Second, the circuit court found that the district court misinterpreted the Computer Fraud coverage’s “direct” loss provisions to limit coverage to unauthorized computer hacking. And third, the Ninth Circuit held that the district court incorrectly limited the Funds Transfer Fraud provision to exclude the consequences of fraudulent instructions given to an Ernst employee.

As to the first finding, the Ninth Circuit declined to follow its prior ruling in Pestmaster Servs., Inc. v. Travelers Cas. & Sur. Co., which involved an embezzlement scheme. The circuit court reasoned that embezzlement is different from the third-party email fraud scheme at issue. In short, the Ninth Circuit held that the Ernst loss did not involve a theft of funds that the thief was ever entitled to hold or receive, as would be the case in an embezzlement.

On the second point, the Ninth Circuit held that a district court finding – that the loss did not result “directly” from computer fraud because Ernst, through its authorized employee, directed the bank to make the fraudulent wire transfers – was rooted in a faulty premise: that a transfer based on fraud was not itself fraudulent. The court explained, in other words, that fraud cannot become “authorized” simply because it worked. To the contrary, the Ernst employee, acting under fraudulent instructions, “directly” caused the subject losses.

Finally, the Ninth Circuit noted that, even if not covered under the computer fraud provisions of the crime policy, the policy still would cover the losses under its funds transfer fraud provisions. The court explained that the district court erred in concluding that the losses did not result directly from fraudulent instructions because the instructions were directed to an Ernst employee rather than at the bank directly. That last error, according to the Ninth Circuit, was based on the district court’s lack of consideration for the express language of the Funds Transfer Fraud provision, which the court found to provide coverage not only for fraudulent instructions sent directly to the bank, but also for fraudulent instructions received by an employee.

Based on the above conclusions, the Ninth Circuit reversed the district court’s summary dismissal and remanded the suit back to the District Court for further proceedings beyond the pleadings stage.

The decision in Ernst & Haas is the most recent of several issued by courts who have grappled with the issue of whether a social engineering fraud is covered under the Funds Transfer Fraud or Computer Fraud coverages. As noted at the outset of this article, courts have reached differing results with respect to whether there is coverage for such claims. The lesson to be drawn from these decisions is that the unique facts, specific policy language, and the applicable law for each claim must be carefully analyzed when evaluating whether a claim for social engineering fraud is covered under the Computer Fraud or Funds Transfer Fraud coverages.

¹ 23 F.4th 1195 (9th Cir. Jan. 26, 2022).

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COURT NEWS

Celebrating the Commonwealth Court’s 50^th Anniversary ...
On Dec. 14, the Pennsylvania Commonwealth Court held its long-overdue 50^th Anniversary celebration in the Rotunda of the Pennsylvania Capitol in Harrisburg. This most impressive gathering in the court’s history featured virtually every current and former judge and court official, leaders from the legislative and executive branches, bar leaders, law professors, and many other esteemed guests—including the two living delegates to the 1968 Constitutional Convention that created the court. The program included the unveiling of outgoing President Judge Kevin Brobson’s portrait, the announcement of a scholarship donation in former President Judge Hannah Leavitt’s name, and remarks from many dignitaries congratulating the court and thanking the judges for their service. Stradley Ronon Appellate Practice Group member Steven Davis serves as President of the Commonwealth Court Historical Society.

...And the Pennsylvania Supreme Court’s 300^th Anniversary
Speaking of anniversaries, the Supreme Court of Pennsylvania has exciting events on tap to commemorate its 300^th Anniversary in 2022. On May 17 and 18, the court will hold a special oral argument session at Old City Hall in Philadelphia. On May 19 and 20, the court will hold a two-day symposium at the National Constitution Center in Philadelphia. The symposium will explore the court’s jurisprudence and role as administrator of the Commonwealth’s judicial system, as well as broader issues relating to our republican form of government. Retired U.S. Supreme Court Justice Anthony Kennedy will lead panelists from the bench, bar, and academia in the discussions.

Third Circuit Vacancies
The news of Justice Stephen Breyer’s retirement and the nomination of Judge Ketanji Brown Jackson to take his place have dominated recent headlines. But there are many other judicial vacancies for President Biden to fill. This includes three seats on the Philadelphia-based U.S. Court of Appeals for the Third Circuit. The first occurred when Judge Theodore McKee took senior status. Arianna Freeman, who currently serves as a managing attorney with the Federal Community Defender Office in Philadelphia, is the nominee to take Judge McKee’s place. Ms. Freeman’s hearing before the Senate Judiciary Committee took place on March 2. The other two vacancies were created by the decisions of Judges Brooks Smith and Thomas Ambro to assume senior status. As of this writing, there are no nominees for either of those seats.

Quotable
“There are loads of countries that have nice written constitutions like ours. But there aren’t loads of countries where they’re followed.” – Justice Stephen Breyer

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

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