An insurer that breached its duty to defend may not later
rely on policy exclusions to escape its duty to indemnify the insured for a
judgment against him, according to a June 11, 2013 decision from the New York
Court of Appeals. The Court of Appeals opinion can be found here.
A legal malpractice insurer had disclaimed a defense duty
under its policy and a default judgment was entered against its insured. When
the judgment creditor sought to enforce the judgment against the insurer, the
insurer asserted coverage defenses based on policy exclusions other than it
asserted in disclaiming its defense duty. The Court of Appeals ruled that the
insurer that had denied its duty to defend could litigate only the validity of
its disclaimer and could not rely on other policy exclusions to dispute its
Goldan, LLC borrowed $2.83 million from two other
companies. The loans were to be secured by mortgages. Goldan defaulted on the
loans. The lenders then learned that the mortgages had not been recorded. The
lenders sued Goldan and two of its principles, Mark Goldman and Jeffrey
Daniels. The plaintiffs asserted a claim against Daniels for legal malpractice,
alleging that Daniels had acted as the plaintiffs' attorney with respect to the
loan and that his failure to record the mortgages was "a departure from good
and accepted legal practice."
Daniels notified his legal malpractice carrier of the
claim, which refused to provide either a defense or indemnity, stating that the
allegations against Daniels "are not based on the rendering or failing to
render legal services for others."
The plaintiffs made a $450,000 settlement demand on
Daniels (an amount well below the malpractice policy's $2 million policy
limit), which Daniels transmitted to the insurer. The insurer rejected the
demand on the same ground on which it had denied coverage. Daniels then
defaulted on the underlying claim and the plaintiffs obtained a default
judgment against him in excess of the policy limit. Daniels assigned his rights
under the malpractice policy to the plaintiffs, who then filed suit against the
insurer for breach of contract and bad faith.
The insurer moved for summary judgment in reliance on two
policy exclusions, the "insured's status" exclusion (which precludes coverage
for claims against an insured in his capacity as an officer, director or
employee of a business enterprise) and on the "business enterprise" exclusion
(precluding coverage for claims based on acts or omissions by any insured for
any business enterprise in which the insured has a controlling interest). The
plaintiffs cross-moved for summary judgment.
The trial court granted summary judgment for the
plaintiffs on the breach of contract action, but granted the insurer's motion
for summary judgment on the bad faith claim. The intermediate court
affirmed both rulings; the appellate court affirmed the breach of contract
ruling on the grounds that the policy exclusions on which the insurer
sought to rely were inapplicable. Two intermediate appellate judges dissented,
arguing that there was an issue of fact whether the exclusions applied. The
The June 11 Opinion
In a ten-page opinion written by Judge Robert S. Smith for
a unanimous court, the Court of Appeals affirmed as to both claims, although
with respect to the breach of contract issue, the Court of Appeals affirmed on
different grounds than relied upon by the intermediate appellate court. The
Court of Appeals did not reach the question of whether or not the exclusions on
which the insurer relied precluded coverage here. Instead, the Court of Appeals
held that when a liability insurer has breached its duty to defend its insured,
the insurer may not later rely on policy exclusions to escape its duty to
indemnify the insured for a judgment against him.
The Court of Appeals first confirmed that the insurer had
a duty to defend the underlying claim. The Court of Appeals noted that the
plaintiffs' claim against Daniels "unmistakably pleads a claim for legal
malpractice." The allegations that Daniels had acted as the plaintiffs' lawyers
in the loan transaction were "unusual" and may even have been "groundless," but
that "does not allow" the insurer "to escape its duty to defend." It might have
been different "if the claim were collusive," but the insurer did not assert
The Court then went on to hold that, having breached its
duty to defend, the insurer could not rely on other grounds to contest a duty
to indemnify its insured. The Court said that "an insurance company that has
disclaimed its duty to defend may litigate only the validity of its disclaimer."
If, the Court said, "the disclaimer is found bad, the insurance company must
indemnify its insured for the resulting judgment, even if policy exclusions
would otherwise have negated the duty to indemnify."
The Court justified this rule by saying that it "will
give insurers an incentive to defend the cases they are bound by law to defend,
and thus to give insureds the full benefit of their bargain." The Court added
that "it would be unfair to insureds, and would promote unnecessary and
wasteful litigation, if an insurer, having wrongfully abandoned its insured's
defense, could then require the insured to litigate the effect of policy
exclusions on the duty to indemnify."
The Court did allow that "perhaps there are exceptions"
to this rule. The Court noted that perhaps an insurer should not be barred from
asserting that its insured injured the plaintiff intentionally. However, the
Court noted, "no such public policy argument is available to [the insurer[
here." Here, the insurer "having chosen to breach its duty to defend, cannot
rely on policy exclusions to escape its duty to indemnify."
Finally, the Court affirmed the lower court's dismissal
of the plaintiffs' bad faith claims. Although the plaintiffs alleged that the
insurer had failed to settle the underlying claim, the Court of Appeals noted
that their claim was really not for a bad faith failure to settle, but for a
bad faith failure to defend. The Court of Appeals said that "we need not decide
...whether such an allegation could ever support a claim for damages in excess of
the policy limit," as "such a claim would require the insured to show, at a
minimum, that the judgment against him would not have been entered if the
insurer had defended the case," which had not been alleged here.
At the heart of the Court of Appeals decision seems to be
a view that this insurer should have defended its insured. The Court of
Appeals clearly did not even consider the defense duty to be a close question.
The underlying claims may have been both odd and groundless, but the insurer
still had the obligation to defend its insured. (Not only that, but it seems
pretty clear that the insurer would have been way better off if it had just
defended its insured.)
At first blush, this seems like a very adverse decision
for insurers. But closer review suggests a reading that is a little less
threatening for the insurers. One possible message from the Court of Appeals
ruling is that this insurer was simply too terse when it denied it had an
obligation to defend; it does seem that if the insurer had cited all of the
alternative grounds on which it eventually sought to rely, it would have been
able to rely on those grounds in contesting coverage. Certainly, going forward,
any insurer denying the duty to defend under a liability insurance contract to
which New York law applies will want to comprehensively state the basis on
which it is denying a defense duty.
On the other hand, even if the insurer here had provided
a more comprehensive basis for its rejection of the duty to defend, and thus
preserved its right to rely on the two policy exclusions, it likely wouldn't
have helped the insurer in the end. A majority of the judges at the
intermediate appellate court - the only court to consider the applicability of
the exclusions on which the insurer sought to rely - concluded that the
exclusions did not apply. Even though two judges dissented, the message seems
to be that the insurer lacked a basis to disclaim a duty to defend. And
so, again, the main message from this case seems to be that insurers should be
very wary of disclaiming the duty to defend (rather than any arguable
alternative message about taking greater care and being more comprehensive when
disclaiming a defense duty).
Even if insurers consider the rule the Court of Appeals
enunciated here to be harsh, the Court did provide one (small) escape hatch.
The Court did acknowledge that there could be public policy exceptions to the
preclusive rule it defined in this case. How broad this public policy exception
might prove to be is unclear. However, I suspect there will be a host of cases
in the future in which this exception will be better defined.
In a June 13, 2013 post on its Insurance Law Blog (here),
a memo from the Traut Lieberman law firm states that the Court of Appeals
decision "announced a new rule," and that previously "New York
courts at both the state and federal level consistently rejected the notion
that by having breached a duty to defend, an insurer is estopped from relying
on coverage defenses for the purposes of contesting an indemnity
obligation." The Court of Appeals decision "departs from this
FDIC Launches Another Failed Bank Lawsuit: On
June 10, 2013, the FDIC as receiver for the failed Sun American Bank of Boca
Raton, Florida, filed a lawsuit in the Southern District of Florida against
seven former directors and officer of the bank. The FDIC's complaint can be
found here. The bank failed on March 5, 2010, well over three years ago,
suggesting that the parties had previously reached some type of tolling
agreement. The FDIC asserts claims against the defendants for negligence and
gross negligence. The FDIC alleges that the defendants failed to use safe and
sound banking practices and failed to adhere to prudent underwriting practices
in approving a total of seven loans.
According to news
reports about the FDIC's lawsuit against the former bank directors and
officers, this latest suit represents the seventh that the agency has filed in
connection with a failed Florida bank. The FDIC has now filed a total of 66
lawsuits against former directors and officers of banks that failed during the
current bank failure wave, including 22 so far during 2013.
other items of interest from the world of directors & officers liability,
with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.
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