Bank’s Overcharging Customer Fees on Overdraft Accounts Not Covered by Professional Liability Insurance Policy and Insurer Granted Judgment in Coverage Dispute

On August 7, 2013, a federal district court in Georgia ruled a bank was not entitled to insurance coverage for a settlement entered into with customers, the plaintiffs in a class action lawsuit (the underlying suit), in which the bank settled with the plaintiffs on charges of wrongfully overcharging for overdraft fees.  Fidelity Bank v. Chartis.U.S.D.C Ga. August 7, 2013.

The bank would charge a fee of $29 each time a customer sought to pay by check or debit an amount in excess of the balance on his or her account.  The $29 fee was charged regardless of the amount of the overdraft created.  So, for example, if a customer with $1.30 on his or her account purchased a cup of coffee for $2.00, the bank would cover the purchase, and then charge its customer $29 in addition to the amount of the purchase (sometimes called a convenience fee / overdraft protection fee, etc.).

The plaintiffs filed suit in Georgia against the bank, alleging violation of Georgia’s civil and criminal usury statutes, common-law conversion, and a common-law claim for “money had and received”.

The insurer had issued a professional liability policy to the bank. The bank notified the insurer of the underlying lawsuit, tendered the claim, and requested defense and indemnity.  The insurer undertook the defense, but refused under a reservation to concede coverage.

The bank entered into a settlement with the plaintiffs in the underlying suit.  The bank then filed a declaratory judgment action seeking a declaration of its rights vis-a-vis the insurance company regarding coverage under the policy.

The policy’s coverage portion provided the insurer would pay the loss of insureds arising from a claim for “any wrongful act of the insured in the rendering of or failure to render professional services”.  The policy defined the term “wrongful act” as “any actual or alleged breach of duty, neglect, error, misstatement, omission or act by the [bank].”  The policy further defined “professional services” as “those services…as set forth in an endorsement to this policy…which services are permitted by law or regulation, to be rendered by an insured pursuant to a written agreement with the customer or client as long as such service is rendered for or on behalf of a customer or client…in return for a fee, commission or other compensation.”

Further, relevant to the case, the policy contained an “exclusion”, which provided the insurer would not be liable “to make any payment for loss in connection with any claim made against any insured…alleging, arising out of, based upon or attributable to, directly or indirectly, any dispute involving fees, commissions or other charges for any Professional Service rendered or required to be rendered by the Insured, or that portion of any settlement or award representing an amount equal to such fees, commissions or other compensations….”. (emphasis added).

The insurer moved for summary judgment, arguing first the policy’s terms did not provide coverage for the claims in the underlying suit. Second, the insurer advanced the alternate argument that coverage was “excluded” based on the language of the exclusion cited above.

The insurer advanced four principal arguments in support of its motion for judgment.  First, it argued the bank’s decision to charge overdraft fees was a deliberate business decision, not a “wrongful act” as defined and applied by the policy.  Second, the insurer argued the underlying lawsuit did not allege claims implicating the bank’s “professional services” as defined and applied by the policy’s terms.  Thus, the claims in the underlying suit were not covered because they were not “wrongful acts”  and therefore the claims were not covered because they were not “wrongful acts” committed in the process of the bank’s rendering of “professional services”.

The insurer also argued what the bank really sought was restitution for its payment to the plaintiffs in settlement; damages which were uninsurable as a matter of law.  Finally, the insurer argued the policy explicitly excluded coverage for amounts paid out to indemnify customers over disputes regarding fees charged by the bank.

The district court grants judgment for the insurer, on the basis of the third and fourth arguments noted above.  (Later on in the opinion, at pages 9 and 10, the court notes it disagrees that the claims did not involve “wrongful acts” for “professional services”, as urged by the insurer in its first two arguments – more on this in a moment).

First, the district court reasons that to require the insurer to pay for a loss the bank incurred in essentially repaying (through settlement of the underlying lawsuit) its customers the overdraft fees would amount to restoring to the bank funds it had taken from its customers’ accounts (and which the bank and subsequently repaid to the customers).  In this vein, the court stated:  “To require [the insurer] to pay restitution for amounts [the bank] collected pursuant to illegal practices would result in a windfall to [the bank].  If this Court were to require [the insurer] to indemnify [the bank] under these facts, it would amount to a ruling that [the bank] is free to collect fees and make profits from its customers through illegal conduct, and the insurer is on the hook when the customers sue while [the bank] keeps the ill-gotten gains.”  Slip. Op. at 6.  The court cites to opinions in other jurisdictions holding that restoration or restitution is not equivalent to damages; damages do not include property or money that is required to be returned to its rightful owner; such restitution or restoration is not a “loss” suffered by the insured and therefore it is and should not be insurable because to so hold would entitle the bank to return of amounts to which it was never entitled).  Id. at 6-8.

The Court then goes on to analyze the exclusion.  After engaging in the unnecessary aforementioned analysis of “coverage” under the policy, the Court evidently realizes the import of the exclusion, which it declares:  “speaks to exactly this type of claim”.  Recall that the exclusion precluded coverage for claims involving fee disputes.

The court disagrees with the plaintiff’s argument that an endorsement to the policy provided coverage despite the exclusion because the endorsement applied to the servicing of loans, and included ostensible coverage for “extensions of credit” (which the bank asserted included extending credit to pay amounts in excess of the amount in a customer’s account).

While the result of this opinion is correct, it is so based on the language of the exclusion, solely and alone.  The court here engaged in needless and confusing discussion about “coverage” and the terms of the coverage portion of the policy, rather than simply analyzing the exclusion.  To be sure, one must always first consider whether a policy’s “terms of coverage” are applicable to the underlying claims.

Careful insurance coverage counsel, and/or those challenging an insurance company’s determinations regarding coverage know the established “order of priority” when analyzing coverage disputes. First, after determining all of the conditional prerequisites of notice and claim are satisfied, and depending on the type of policy (claims made or “occurrence” based), one must then carefully peruse the precise terms of “coverage” as applied to the underlying claims and the nature of the facts being alleged.

The court rescues its oversight on pages 9 and 10 of the opinion by going back and showing that the “terms of coverage” in the policy clearly would have applied to the claims in the underlying suit.  The fees were charged within the boundaries of law and regulation, and the terms of the bank’s written agreement with its customers.  (Again, the underlying lawsuit resulted in a “settlement” by and between the bank and its customers – part of which was obviously recompense for the alleged overcharge fees.  So, there was also no need for the district court to engage in unnecessary dicta about the illegality or unlawfulness of the conduct in question – this is not a “conspiracy” or “intentional fraud” claim or case).  This clouds the discussion about the nature of “professional liability policies” and whether and to what extent coverage extends in the given case.  Contrast this underlying set of facts with those at issue in the blog post I earlier submitted: Errors and Omissions Policies Do Not Cover True Conspiracies / Schemes to Defraud Providers and Patients

Notwithstanding these unnecessary discussions by the court in the instant case, as every coverage counsel knows, coverage is not the end of the inquiry.  Here, the exclusion’s plain language clearly applies to exclude coverage for otherwise covered claims for “wrongful acts” in the provision of “professional services” if such arise out of a dispute concerning the precise type of overdraft fees the bank was charging.

However, something that appears to have been overlooked by the court is the exclusion excludes coverage only for that portion of any settlement or award representing an amount equal to such fees, commissions or other compensations….” (emphasis added).  If I were advocating for the bank, and applying the proper analytical framework to engaging the order of priority in the policy, I would assert there is a clear separation in the exclusion for “true damages” arising out of “covered claims”, those representing true losses by the bank, whether by way of compensatory damages realized by the claimants after suit, or such an amount as was represented in the settlement, and simply payments made in restitution (which the court here explains is against common law and policy – and, ultimately, realizes this precise policy (not insuring against what are not true losses) is the purpose of the exclusion itself).

Perhaps partial summary judgment was appropriate, leaving it to be factually determined whether coverage should still be available based on the separation in the amounts paid in settlement that represented compensation (compensatory damages), and the amount paid back to the plaintiffs for return of their property (those amounts the banks charged to (and received from) the plaintiffs’ accounts).

If you would like more information about these issues contact Carson J. Tucker, Chair of the Appeals and Legal Research Group and the Insurance Coverage and Recovery Group at Lacey & Jones, LLP.

Lacey & Jones, LLP’s Insurance Coverage and Recovery Group

Continuing its tradition of providing highly specialized and unique legal services to an exclusive clientele, Lacey & Jones, LLP, works with insurance companies and businesses to develop comprehensive insurance coverage strategies for all lines of coverage.  From the simplest review (second look) of an in-house counsel’s coverage determination to complete coverage analysis involving high-exposure, multi-party, multi-jurisdiction, multi-claim events, the firm is capable of assisting its clients in making valuable choices and advising them on the proper course of action.  The firm’s coverage counsel and litigation team is also capable of pursuing coverage determinations and indemnity or subrogation in courts by filing declaratory judgment actions or indemnity and subrogation actions, respectively.

Our attorneys have successfully navigated coverage cases in state and federal courts, involving multiple insurers, multiple claimants and multiple forums to arrive at favorable resolutions for our clients in eight figure exposure cases, including, but not limited to, environmental liability claims, construction claims, professional liability claims, catastrophic personal injury claims, and product liability claims.  Our coverage lawyers speak the language of insurers and understand the intricacies of policy coverage involving multiple insurers, multiple policy forms, and multiple layers and years of coverage.

    • Declaratory Judgment Actions
    • Coverage Analysis and Strategy
    • Property and Casualty Claims
    • General Liability Claims
    • Business Risk
    • Indemnity and Subrogation
    • Product Liability Claims
    • Construction Defect Claims
    • Government and Municipal Liability Claims
    • Workers’ Compensation Claims

Health Care Plan Provider’s Conspiracy / Scheme to Underpay Insurance Claims Submitted by Providers and Beneficiaries Not “Errors or Omissions” and Reinsurance Policies Covering Professional Liability Policies Not Implicated

In June, a Court of Appeals panel in Indiana issued an unpublished, and therefore, non-binding, opinion speaking to an issue that has significant relevance for several of our insurer and employer clients, and third-party claims administrators with whom we work.

The insurance coverage case, Wellpoint, Inc., et al. v. National Union Fire Ins. Co., et al, arose out of allegations in the underlying lawsuits that a network of health insurance companies, Wellpoint, Inc. and Wellpoint Health Networks, Inc., eventually merged into Anthem (hereafter referred to simply as Wellpoint unless otherwise indicated), conspired with other health insurance companies to deny medical providers’ and doctors’ claims for reimbursement of health care services.

The Underlying Lawsuits – The Alleged Conspiracy 

The plaintiffs in the first underlying suit were members of a health plan issued by Wellpoint, which permitted beneficiaries to use the services of out-of-network providers.  The plaintiffs filed an action in Connecticut state court against the Indianapolis-based health insurer, Wellpoint, accusing the company of, among other things, conspiring to underpay for out-of-network payments.  The plaintiffs sought damages for allegedly having received artificially low payments from WellPoint for the reimbursement of out-of-network services.  The lawsuit accused Wellpoint of colluding with other health insurers to deliberately underpay physicians, pushing the burden of excessive payment onto Connecticut patients.

The plan with which the plaintiffs in the underlying suit were associated permitted beneficiaries to use the services of out-of-network providers.  Services at out-of-network providers were reimbursed at the lesser of the billed charge or the “usual and customary” rate (UCR).  Any amount charged for out-of-network services beyond the UCR was the responsibility of the plan member, i.e., the plaintiffs (particularly the physicians).  In making UCR determinations, WellPoint relied on databases owned by Ingenix Inc., which is a wholly owned subsidiary of United HealthCare Corp.

WellPoint was a major contributor of provider charge data for the databases and deleted valid high charges before providing the information to Ingenix, which then removed additional high charges from the data, according to the complaint.  The plaintiffs contended that the Ingenix databases were inherently flawed and invalid and, thus, were an inadequate and improper basis for UCR determinations.  Because WellPoint’s health plans covered out-of-network services only to the extent of the UCRs they used, the plaintiffs say they and thousands of others had to pay more for out-of-network services then they would have absent a conspiracy to manipulate the reimbursement rates.

The plaintiffs’ class action lawsuit alleged, among other things, that Wellpoint failed to timely and adequately reimburse for medical services provided.  The plaintiffs’ complaint contained claims alleging breach of contract, conversion, tortious interference with business expectations, breach of good faith and fair dealing, violation of the Connecticut Unfair Trade Practices Act, and violation of the Connecticut Unfair Insurance Practices Act.

Subsequent to the filing of the aforementioned suit, Wellpoint was sued by several other plaintiffs and plaintiffs groups across the country.  The lawsuits alleged similar practices and included similar claims against Wellpoint.  Claims in these lawsuits also alleged Wellpoint violated the Racketeer Influence and Corrupt Organizations Act (RICO).

Wellpoint’s Insurance Coverage

Anthem (successor to Wellpoint) had set up a complex and multi-tiered arrangement to reinsure itself for “errors and omissions” liability.  (As noted by the Indiana Court of Appeals, “Errors and omissions” coverage is designed to insure members of a particular professional group from the liability arising out of a special risk such as negligence, omissions, mistakes, and errors inherent in the practice of the profession. Stevenson v. Hamilton Mut. Ins. Co., 672 N.E.2d 467, 473 (Ind. Ct. App. 1996), reh’g denied, transfer denied. An errors and omissions insurer of a business does not have the duty to indemnify for the malicious and intentional, rather than careless and negligent, acts of the insured, even where the policy does not specifically exclude intentional acts. Id.)).

The insurance arrangements involved (1) a primary insurance policy, which Anthem issued to itself; (2) a certificate of reinsurance on the primary policy issued by National Union Fire Insurance Company; (3) four excess insurance (or umbrella) policies, which Anthem also issued to itself, each of which “followed form” to the primary policy (incorporating the terms and conditions of coverage (and the exclusions) in the primary policy); and (4) numerous certificates of reinsurance on the excess policies issued by a bevy of additional reinsurers (including Reliance Insurance Company (which went bankrupt and was replaced mid-term of the policy period by Twin City Fire Insurance Company)), in which the reinsurers agreed to assume the rights, powers, privileges, duties and obligations as insurers under Anthem’s policies.  The effective dates on all of the policies spanned from September 30, 1999 to September 30, 2002.

Wellpoint’s Request for Defense and Indemnification from its Insurers

Wellpoint tendered the claims in the underlying lawsuits to its insurers and reinsurers, seeking defense and indemnity under the policies.  The insurers (including the reinsurers) refused to undertake the defense of Wellpoint and denied coverage.

Wellpoint filed suit in Indiana state court seeking, among other things, coverage from its reinsurers for claims in the underlying lawsuits.  Twin City counterclaimed seeking a declaration it owed no coverage for specific claims, as well as others in the underlying lawsuits.  The trial court initially granted a summary judgment to Twin City on arguments relating to the time period that the initial claims were made (recall these were “claims made” policies – finding the claims were made and reported before Twin City’s coverage period)) and on the argument that post-2000 claims were interrelated, and related to, the prior claims under the terms of two exclusions in the policy and thus coverage was excluded for those latter claims as well.  In a separate opinion, Wellpoint Inc v National Union Fire Ins Co, 952 N.E.2d 254 (2011), the Indiana Court of Appeals reversed the trial court in that regard.  (On a separate note, perhaps demonstrating its self-imposed status as a forum known for handling significant and complex business insurance disputes, the Indiana Court of Appeals in this aforementioned opinion provides a remarkably detailed analysis of the timing of notice and claims under claims made policies, in conjunction with the timing requirements of the insuring agreements vis-a-vis the separate claims in the underlying lawsuits).

However, in this case, the Indiana Court of Appeals addressed Wellpoint’s remaining suit against the insurers and reinsurers seeking coverage for its subsequent settlement of all the claims in the underlying lawsuits.  Wellpoint claimed professional liability coverage under Part II of the policies, which provided in part that the policies would pay the “Loss of the Insured resulting from any Claim or Claims first made against the Insured . . . for any Wrongful Act of the Insured . . . but only if such Wrongful Act . . . occurs solely in the rendering of or failure to render Professional Services.”  The trial court had granted the reinsurers’ motion for summary judgment, holding the claims against Wellpoint did not arise out of acts that occurred “solely in the rendering of or failure to render professional services”. (emphasis supplied).  The Court of Appeals affirmed.

Noting the policy defined the term “professional services” in this instance as “services rendered or required to be rendered solely in the conduct of the insured’s claims handling or adjusting”, the Court of Appeals reasoned coverage was available only if the alleged wrongful acts that gave rise to the underlying litigation happened solely in the conduct of Wellpoint’s claims handling and adjusting.

The Court of Appeals concludes this was not the case.  The underlying lawsuits primarily involved violations under two statutes. Some of the plaintiffs set forth claims for breach of contract, conversion, tortious interference with business expectations, breach of good faith and fair dealing, and violation of the Connecticut Unfair Trade Practices Act (CUTPA).  Other plaintiffs had alleged in part that Anthem conspired with other managed-care organizations to deny, delay, and diminish payments to doctors and set forth causes of action under the Racketeer Influence and Corrupt Organizations Act.  The RICO plaintiffs also asserted other claims including breach of contract and violations of prompt-pay statutes.

As the wrongful acts alleged in the underlying complaints were not professional services in the form of claims handling or adjusting, the Court of Appeals held the policies at issue did not provide coverage for Wellpoint. The majority agreed with the trial court, which had noted the “underlying complaints do not simply allege that [Wellpoint] improperly denied claims. Rather, they allege [Wellpoint] participated in ‘a common scheme’ to ‘systematically deny, delay, and diminish the payments due to doctors.’” It found “the conduct that was central to the RICO claims was [Wellpoint’s] unlawful agreement with other managed care companies to unlawfully reduce payments to Providers,” and such unlawful agreements and conspiracies are not claim handling activities.

Also allegations against Wellpoint did not involve such “mistakes inherent in the practice of that particular profession or business,” they were not “professional services” covered by the Continental and Twin City policies.  The gravamen of the claims against Wellpoint was, as the trial court correctly noted, allegations Wellpoint participated in a common scheme to systematically deny, delay, and diminish the payments due to doctors, and “the conduct that was central to the RICO claims was [Wellpoint’s] unlawful agreement with other managed care companies to unlawfully reduce payments to Providers,” and such unlawful agreements and conspiracies are not professional services in the form of claim handling activities  Even if some professional services were implicated, the underlying actions did not arise “solely” out of Wellpoint’s rendering or failure to render such services. (emphasis in original opinion).

After determining the alleged conspiracies and unlawful agreements were not “professional services,” the trial court found they “plainly did not occur solely in the performance of claims handling”; they were, rather, allegations of conduct in furtherance of the RICO conspiracies including Wellpoint’s involvement in trade associations that developed industry standards and in industry groups that disseminated unified information and exchanged upper-level employees in order to facilitate unified action, and its participation in a managed care enterprise.

Notably, the Court of Appeals also refused to accept Wellpoint’s attempt to “bifurcate” the claims in the underlying lawsuits, some of which, it alleged, did properly implicate the policy’s coverage of “errors and omissions” in the rendering of “professional services” as further defined by the policies.  On this point, the Court of Appeals reasoned the terms of the policy provided coverage only for allegations against Wellpoint that arose “solely”, i.e., exclusively or entirely, out of its claims handling activities.  Since the common theme of the underlying lawsuits alleged a conspiracy and designed scheme which was not the provision of professional services within the meaning of the policies, the allegations did not arise “solely” or “exclusively” out of the provision of professional services.

One judge of the three judge panel dissents, arguing there is a question of fact, at least, whether all claims did or did not arise out of the common scheme.  The dissenting judge also argues the majority reads the “exclusivity” provision too narrowly with reference to the use of the term “solely”.

Transfer of the case to the Indiana Supreme Court is likely to be pursued by the losing party.  It is an important and enlightening opinion, which provides important guidance to both insurers and insureds in the conducting of their day-to-day business insurance interests.

Lacey & Jones, LLP’s Insurance Coverage and Recovery Group

This is a very significant case that provides guidance to insurance companies, businesses, and third-party administrators in the day-to-day operation of their affairs.

If you would like more information about this case contact Carson J. Tucker, Chair of the Appeals and Legal Research Group and the Insurance Coverage and Recovery Group at Lacey & Jones, LLP

Continuing its tradition of providing highly specialized and unique legal services to an exclusive clientele, Lacey & Jones, LLP, works with insurance companies and businesses to develop comprehensive insurance coverage strategies for all lines of coverage.  From the simplest review (second look) of an in-house counsel’s coverage determination to complete coverage analysis involving high-exposure, multi-party, multi-jurisdiction, multi-claim events, the firm is capable of assisting its clients in making valuable choices and advising them on the proper course of action.  The firm’s coverage counsel and litigation team is also capable of pursuing coverage determinations and indemnity or subrogation in courts by filing declaratory judgment actions or indemnity and subrogation actions, respectively.

Our attorneys have successfully navigated coverage cases in state and federal courts, involving multiple insurers, multiple claimants and multiple forums to arrive at favorable resolutions for our clients in eight figure exposure cases, including, but not limited to, environmental liability claims, construction claims, professional liability claims, catastrophic personal injury claims, and product liability claims.  Our coverage lawyers speak the language of insurers and understand the intricacies of policy coverage involving multiple insurers, multiple policy forms, and multiple layers and years of coverage.

    • Declaratory Judgment Actions
    • Coverage Analysis and Strategy
    • Property and Casualty Claims
    • General Liability Claims
    • Business Risk
    • Indemnity and Subrogation
    • Product Liability Claims
    • Construction Defect Claims
    • Government and Municipal Liability Claims
    • Workers’ Compensation Claims

New York’s Highest Court Holds Insurer Responsible Up to Policy Limits Where It Refused to Defend Attorney in Underlying Suit Alleging Professional Malpractice for the Lawyer’s Conduct Acting in His Capacity as a Principal of a Business and Insurer Could Not Invoke Policy Exclusions to Coverage

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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