This is a rather unremarkable case from the point of view of the legal rules expressed by the opinion, but I wanted to highlight a few significant points for clients to consider when addressing the parameters of an insurer’s duty and the risk involved in not taking affirmative action if a dispute arises or, better yet, is anticipated.
The facts are somewhat peculiar, bringing into question a professional liability insurer’s duty to defend and indemnify claims regarding a business deal engaged in by its insured (an attorney) in which there appears no doubt the attorney was acting as a businessman and not an attorney in the endeavors that gave rise to the underlying claims.
The opinion, K2 Inv Group LLC v American Guarantee And Liability Ins Co, N.Y. Court of Appeals, No. 106, June 11, 2013, was released by New York’s highest court in June. It demonstrates intolerance courts usually have where an insurer disclaims a duty to defend the insured in an underlying lawsuit and later claims it had no duty to do so because the policy would have precluded or excluded coverage. There are some other important takeaways from the decision, as explained below.
The defendant in the underlying suit was an attorney. He was part owner of a company (the borrower) that engaged in a loan transaction for $2.83 million with the plaintiffs in the underlying suit (the lender), which was comprised of two separate companies. The lender’s loan was to be secured by mortgages, the recording of which was to be the responsibility of the borrower. However, the borrower failed to record the mortgages and subsequently defaulted on the unsecured loan. The lenders filed suit against the borrower and its two principals, including the attorney. Each of the lender companies included counts alleging legal malpractice against the attorney.
The attorney notified his malpractice insurer of the suit. The policy limit was $2.5 million. The insurer disclaimed a duty to defend the attorney and indemnify him for the claims against him, concluding, in part, the claims in the underlying suit were not “based on the rendering or failing to render legal services for others” and did not constitute the type of professional malpractice for which its policy provided coverage. After the insurer issued its disclaimer, the plaintiffs made a settlement demand against the defendants in the underlying suit in the amount of $450,000. After it was presented with the demand, the insurer again rejected it on the same bases that it had disclaimed a duty to defend and indemnify the attorney.
A default judgment in excess of the policy limits was entered in the underlying suit against the attorney. All the remaining claims against the other parties were discontinued. The attorney then assigned his claims against his malpractice insurer to the plaintiffs in the underlying lawsuit. The plaintiffs stepped into the attorney’s shoes and sued the malpractice insurer alleging bad faith and breach of contract.
The malpractice insurer moved for summary judgment, invoking two exclusions in the professional liability policy. The first excluded coverage of claims based on or arising out of, in whole or in part, the insured’s capacity or status as a member, partner, employee, etc., of a business enterprise. The second exclusion applied to claims based upon or arising out of the alleged acts or omissions of the insured while engaged in or for a business enterprise. The insurer argued the claims in the underlying suit against its insured had arisen out of his capacity or status as a business owner and out of his acts or omissions on behalf of the business.
The plaintiffs filed a cross-motion for summary judgment. The trial court denied the insurer’s motion and granted the plaintiffs’ motion on the breach of contract claim, while dismissing the bad faith claim.
The trial court reasoned the insurer had breached its duty to defend and was therefore responsible up to the limits of its policy for the judgment that had been entered against the attorney in the underlying lawsuit. On appeal, the court affirmed, holding that the exclusions relied on by the insurer were inapplicable. Two justices dissented on the basis that questions of fact existed as to whether the exclusions would apply – essentially the dissent would have allowed the insurer to re-apply the provisions of the policy (here the specific exclusions) to the dispute despite is refusal to extend a defense to the attorney in the underlying suit.
The insurer appealed. The New York Court of Appeals affirmed. The Court held that where a liability insurer breaches its duty to defend (or disclaims that duty), it cannot later rely on any specific provisions of the policy’s coverage terms (or exclusions) to escape its duty to indemnify the insured for a judgment obtained against the latter.
The opinion restates some familiar principles that are adhered to in a number of jurisdictions. First, the duty to defend is broader than the duty to indemnify (the duty embraces claims alleged in the underlying complaint no matter how baseless they are if there is any reasonable chance the insuring agreement provides coverage). An insurer that either disclaims its duty to defend (without a reservation) and fails to affirmatively seek a declaration concerning that disclaimer (by filing a declaratory judgment action), puts itself at risk that it will be responsible, at least, for any good faith settlement entered into between the insured and the plaintiff / claimant in the underlying suit, or, worse, as in the instant case, for the amount of a judgment obtained in that suit up to the limits of its policy.
On this latter point, it should be noted that some jurisdictions would not even allow an insurer the benefit of invoking its policy limits where it has breached its duty to defend without reservation and without seeking a declaration of its rights. This is because once the insurer essentially disclaims that the insuring agreement provides the basis of any assessment of claims lodged against its insured, it takes itself out of the contractual terms of that agreement and puts itself at the mercy of the law of the jurisdiction controlling the dispute. So, if a jurisdiction allows a quasi-contractual claim – such as estoppel, unjust enrichment, or bad faith (or some equivalent) – against the insurer by the insured (or the plaintiff who has been assigned the latter’s claims against the insurer as in this case), the insurer could face liability that actually exceeds its policy limits. In other words, the insurer could be liable for the total amount of the judgment entered against the insured or a settlement entered into by the parties. Here, that would have resulted in a judgment that exceeded the insurer’s policy limits by $300,000.
On this point, the Court quoted from another opinion:
It is well settled that an insurance company’s duty to defend is broader than its duty to indemnify. Indeed, the duty to defend is exceedingly broad and an insurer will be called upon to provide a defense whenever the allegations of the complaint suggest a reasonable possibility of coverage. If, liberally construed, the claim is within the embrace of the policy, the insurer must come forward to defend its insured no matter how groundless, false or baseless the suit may be.
The duty remains even though facts outside the four corners of the pleadings indicate that the claim may be meritless or not covered…. Thus, an insurer may be required to defend under the contract even though it may not be required to pay once the litigation has run its course.
Further, the act of disclaiming a duty to defend without reservation and without seeking a declaration as to its rights under the policy also prevents the insurer from allowing a determination of coverage. It may be, as the dissent in the lower appellate division noted, that a question of fact existed concerning whether the exclusions in the policy did indeed absolve the insurer of a duty to indemnify. And, it appears from the facts presented that the attorney’s acts and conduct did fall within either or both of these exclusions. The crucial point however was the underlying complaint did also allege acts of malpractice because of the attorney’s company’s responsibility to record the mortgages that secured the loans to his company. Thus, the insurer could not rely on the obviousness of the true nature of the transaction, but rather its conduct was dictated by the allegations in the underlying complaint.
The Court noted it was indeed curious that the lenders in a loan transaction would have retained a principal of the borrower’s company to serve as an attorney to act as their lawyer, but that did not absolve the insurer from defending the claims alleging malpractice in the underlying lawsuit.
The Court does give some important guidance on ways in which an insurer may be able to yet challenge its failure to defend. Noting the possibility that a court might absolve the insurer if it could be shown the underlying transaction implicated a reason to deny coverage based on public policy. On this point, the Court noted that in the proper case an insured’s disclaimer of its duty to defend its insured in the underlying action may not bar it from asserting that its insured engaged in intentional wrongdoing for which it should not be provided insurance.
The court also alludes to the possibility that if the insurer can prove collusion between its insured and the plaintiffs in the underlying case to devise a plan whereby the latter could seek compensation from the former’s insurer, the insurer might have been able to escape its primary duty to defend. However, no such facts were alleged or apparent from the case.
This case has been out for over a month and has gotten widespread attention. Although, that may be the result of the forum from which it issued rather than its statements of law, which, again are fairly typical. For insurers and business owners though there are takeaways from this case that teach important, simple lessons when approaching a claim for insurance arising out of any incident.
- An insurer that disclaims a duty to defend without a reservation of its rights and without seeking a declaration as to its coverage obligations under the policy, cannot rely on the policy’s terms or exclusions, which might otherwise allow it to avoid coverage of the underlying claims if it has disclaimed its duty to defend.
- When an insurer breaches its duty to defend, it is liable to the insured (and his or her assignee) for, at least, the full amount of the policy’s limits, to cover the liability resulting from the underlying lawsuit.
- It is important to assert any defenses to coverage (terms and exclusions) in the policy at the outset, even while agreeing to provide a defense.
- It may be wise to seek a second-look coverage opinion from able counsel to determine what strategies are advisable. Here, the underlying complaint alleged malpractice. Regardless of the suspicious nature of the underlying transaction involved, the insurer would have been wise to provide a defense under a reservation of rights and then seek a declaration of its rights from an independent source (usually the filing of an declaratory judgment action in court, although there may be alternate ways to resolve the dispute).
- It is also advisable to consider whether any evidence of fraud or collusion might exist between the parties in the underlying dispute (as the court noted in this case, the transaction itself was rather curious and although it pointed out there was no evidence of it, the court made sure to note the possibility that intentional wrongdoing, fraud or collusion might have absolved the insurer from having to defend the claim).
- Presumably, the insurer in this case could have paid the $450,000 settlement offered and would have been done with the case. Not to say that concession is always advisable.
- From a practical perspective, I believe the insurer was rightly skeptical of the nature of the transactions underlying this case; however, agressive claims handling rather than simply disclaiming a duty to defend may have been the wisest choice in this case.
If you would like more information about this case contact Carson J. Tucker, Chair of the Appeals and Legal Research Group at Lacey & Jones, LLP
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