The opinion of the court was delivered by: O'hern, J.
On certification to the Superior Court, Appellate Division, whose opinion is reported at 294 N.J. Super. 569 (1996).
The primary question in this appeal is whether insurance coverage exists under the employers liability section of a workers' compensation policy for claims of workplace sexual harassment when the harassment results in bodily injury. The specific question is whether the policy's exclusion of coverage for damages arising out of harassment (among other things) is effective to deny such coverage. We find that to the extent the exclusion would deny coverage for bodily injury caused by acts of sexual harassment in the workplace, the exclusion would prevent an employer from complying with N.J.S.A. 34:15-71, which requires employers to "make sufficient provision for the complete payment of any obligation [the employer] may incur to an injured employee." Accordingly, we affirm the judgment of the Appellate Division, which is reported at 294 N.J. Super. 569 (1996). In American Motorists Insurance Co. v. L-C-A Sales Co., ___ N.J. ___ (1998), also decided today, we examine whether the "employee exclusion" of an employer's comprehensive general liability policy bars coverage of an employee's claim of age discrimination.
Lisa M. Schmidt filed a complaint in September 1991 against her employer, Personalized Audio Visual, Inc. (PAV) and Dennis Smith (Smith), the president of PAV. (Because of the similarity of the names (Schmidt and Smith), we shall refer to plaintiff as "Lisa.") PAV ran the business center at the Somerset Hilton Hotel. In her initial complaint, Lisa alleged that Smith committed hostile work environment sexual harassment in violation of New Jersey's Law Against Discrimination (LAD), N.J.S.A. 10:5-1 to -42, assault, battery, invasion of privacy and intentional infliction of emotional distress. She alleged that Smith demanded that she have sex with him, that he attempted to force "his tongue down her throat," and that he fondled Lisa's buttocks and breasts. Lisa alleged that these acts took place between January 2, 1991 and February 19, 1991, during and immediately prior to her employment by PAV. Two years later, in July 1993, Lisa filed an amended complaint that alleged for the first time that PAV and Smith were liable to Lisa under negligence theories, namely, that Smith had negligently inflicted emotional distress and that PAV had negligently failed to train or supervise her superior.
PAV and Smith (as an employee of PAV) demanded defense and indemnification in the lawsuit from United States Fidelity & Guaranty Company (USF&G), initially under a comprehensive general liability (CGL) policy and later under the employer's liability portion of a Workers' Compensation and Employers' Liability policy (Workers' Compensation policy). USF&G denied coverage under both policies. PAV and Smith instituted a third-party declaratory judgment action against USF&G on the coverage issue. The trial court accepted USF&G's argument that Lisa's case should be tried before the coverage action. The trial court urged USF&G to participate in that trial, but USF&G declined to do so.
In the trial of Lisa's claims against PAV and Smith, the jury found Smith liable to Lisa for hostile work environment sexual harassment, assault, assault and battery, and intentional infliction of emotional distress. PAV was held liable for the hostile work environment sexual harassment alone. The jury was not asked whether PAV's liability was direct or vicarious, and it was not asked whether PAV could be vicariously liable for the intentional torts Smith had committed. The jury awarded compensatory damages of $80,000 to Lisa but did not allocate those damages to the different causes of action. The trial court entered judgment against PAV and Smith in the amount of $181,730.36, which included the compensatory damage award, $82,313.50 in counsel fees under LAD, and prejudgment interest and disbursements.
On cross-motions for summary judgment in the coverage actions, the trial court found that USF&G had a duty to defend Smith and PAV as well as a duty to indemnify PAV.
On appeal, the Appellate Division affirmed that part of the judgment that required USF&G to indemnify PAV for the full amount of Lisa's judgment and to reimburse PAV and Smith for all defense costs incurred by them. The Appellate Division agreed with USF&G that there was no duty to defend or indemnify PAV under the terms of the CGL policy. It held, however, that USF&G was obliged to defend and indemnify PAV under the employer's liability coverage of the Workers' Compensation policy. The court reasoned that the exclusion in that coverage for harassment was not applicable to sexual harassment claims when liability for those claims was imposed vicariously and not directly. It declined to apportion the defense costs as between Smith and PAV. We granted USF&G's petition for certification. 148 N.J. 461 (1997).
Before considering the terms of the policy, we digress to review the nature of the insurance involved here. Under New Jersey law, injuries that arise in and out of the course of employment are compensable through the system of Workers' Compensation laws. N.J.S.A. 34:15-1 to -142. Absent a specific election not to be covered, every employee is deemed to have elected the Workers' Compensation remedy for occupational injuries. N.J.S.A. 34:15-9. In exchange for this statutory remedy, the employee surrenders rights to sue the employer or fellow employees at common law except in cases where the injury stems from intentional wrongs committed by the employer or the fellow employees. N.J.S.A. 34:15-8. In order to assure that this statutory remedy given in lieu of a common law remedy is not illusory, the Legislature has required that every employer carry Workers' Compensation insurance. Those policies must cover not only claims for compensation prosecuted in the Workers' Compensation court, but also claims for work- related injuries asserted in a common law court. N.J.S.A. 134:15-72. Thus, in Variety Farms, Inc. v. New Jersey Mfrs. Ins. Co., 172 N.J. Super. 10 (1980), the Appellate Division held that when a minor elected to seek a common law tort claim to recover compensation for injuries (workers under 18 years of age are exempt from the exclusivity provisions of the Workers' Compensation Act, N.J.S.A. 34:15-10), the employer's Workers' Compensation policy was required to provide coverage even though the policy contained a specific exclusion for employment that violated the law. (The plaintiff in that case was hurt while operating power-driven machinery. N.J.S.A. 34:2-21.17, a section of the Child Labor Law, prohibits the employment of minors under 16 to work with such machines.) In short, the terms of a policy issued pursuant to N.J.S.A. 34:15-78 cannot conflict with the statutory mandate that there be coverage provided for all occupational injuries.Employers liability coverage, as the Appellate Division noted, "is traditionally written in conjunction with workers' compensation and is intended to serve as a `gap-filler' providing protection to the employer in those situations where the employee has a right to bring a tort action despite provisions of the workers' compensation statute." Producers Dairy Delivery Co. v. Sentry Ins. Co., 718 P.2d 920, 927 (Cal. 1986).
The Appellate Division summarized the policy provisions and the exclusions relevant to this appeal. The employers liability insurance here "applies to bodily injury by accident or bodily injury by disease," which arises "out of and in the course of the injured employee's employment" by the insured. Under the policy USF[&]G agreed to pay "all sums [PAV] legally must pay as damages because of bodily injury to [PAV's] employees, provided the bodily injury is covered by this Employers Liability Insurance." The pertinent exclusions to the policy are as follows:
This insurance does not ...