The First Department recently held that broadly worded exclusions in insurance policies designed to preclude collusive claims do not necessarily exempt insurers from liability. K2 Investment Group, LLC, v. American Guarantee & Liability Ins. Co., 2012 NY Slip Op 1; 2012 N.Y. App. Div. LEXIS 16 (1st Dep't 2012). The specific policy at issue was a lawyers professional liability policy with two exclusions intended to prevent a policyholder from profiting by his or her own malpractice. The "insured's status exclusion" excludes coverage for claims arising out of an insured's capacity or status as an officer, director, etc., of a business enterprise. The "business enterprise exclusion" excludes coverage for any claim arising out of the alleged acts or omissions of the insured for any business enterprise in which the insured has a controlling interest. The Court held that the policy did not exclude coverage for all conduct occurring while the insured was an owner or officer, but only for claims arising out of the insured's capacity. As such, and limited strictly by the allegations in the complaint, the Court took a very narrow view of the language.
The Plaintiffs were limited liability companies that made loans amounting to $2,830,000 to Goldan, LLC. Goldan consisted of two members, Jeffrey Daniels, who happened to be an attorney, and Mark Goldman. Daniels personally guaranteed the loans. As part of the loan transactions, mortgages were to be filed and title insurance obtained for the benefit of the Plaintiffs. Apparently, the mortgages were never filed and title insurance was not obtained.
American Guarantee & Liability Insurance Company ("American Guarantee") issued a lawyers professional liability policy to Daniels. Daniels notified American Guarantee of a potential claim arising from the loan transactions, advising that the Plaintiffs "have indicated that they believed I was representing their interests" in filing mortgages against real property, though he had "no personal knowledge of these mortgages" as Goldman negotiated them directly with the Plaintiffs. He also reported that his law firm provided services to Goldan on a retainer basis.
The Plaintiffs filed suit against Daniels, Goldan, and Goldman after defaults occurred on the loans. The Plaintiffs claimed that Daniels represented them in the loan transactions and committed malpractice by not recording the mortgages or obtaining title insurance. They also sued Daniels on the personal guarantees that he signed. At first, American Guarantee provided a defense to the claims and issued a reservation of rights, asserting the exclusion based upon the insured's status as a member of Goldan and the exclusion for any claim arising out of alleged acts or omissions of the insured for any business enterprise in which he had a controlling interest. However, American Guarantee later withdrew the defense and disclaimed any coverage for the claims. The Plaintiffs demanded that American Guarantee settle the claims against Daniels for $450,000. (The policy limits were $2 million.) American Guarantee declined to settle and eventually a default judgment was entered against Daniels in excess of $3 million. Daniels assigned his rights and claims against American Guarantee to the Plaintiffs, who in turned filed suit against American Guarantee to recover the judgment.
In a three to two decision, the majority ruled that neither exclusion applied and that American Guarantee was liable for its policy limits. The Court noted that American Guarantee could not challenge the liability or damages determination underlying the judgment because it had disclaimed the duty to defend its insured. Prior to the default judgment, the Plaintiffs withdrew the cause of action against Daniels based upon his personal guarantees and proceeded against him solely on the malpractice claim. As a result, American Guarantee was not allowed to assert defenses that Daniels was representing Goldan in the transaction, or that he was not representing the Plaintiffs, because the allegations in the complaint were focused solely on Daniels's negligence as Plaintiffs' counsel. The fact that Daniels was an owner of Goldan or might have been acting in the interests of Goldan instead of his clients did not change the essence of the complaint or the basis of liability. Neither exclusion applied, because there was no claim in the complaint that Daniels was negligent in performing services for Goldan. According to the Court, "the action was based exclusively on his obligation to [P]laintiffs, not to Goldan." The policy did not exclude coverage for all conduct occurring while Daniels was an owner or officer, but only for claims arising out of his capacity as such.
In a lengthy dissenting opinion, Justices Andrias and Tom argued that the majority's conclusion was based upon too narrow a reading of the broad language of the policy, which expressly states that the policy "shall not apply to any Claim based upon or arising out of, in whole or in part, etc. (emphasis added) the insured's capacity or status as an officer or director of a business enterprise or from the alleged acts or omissions of the insured for any business enterprise in which he has a controlling interest." The dissent noted that "[w]ords like 'arising from,' when used in exclusion clauses, are generally taken as a broad and comprehensive reference to events originating from, incident to, or having connection with the subject of the exclusion." Id. at 7.
Moreover, and according to the dissent, even if the default judgment mandated a finding that Daniels is liable to Plaintiffs, it does not foreclose a finding that Daniels represented both Goldan and Plaintiffs and his conduct fell within the ambit of the insured's status exclusion and/or the enterprise exclusion, because his failure to file the mortgages and obtain title insurance was a business decision to benefit his company, Goldan. The dissent pointed to the notice of potential claim, where Daniels advised American Guarantee that, to the extent that he provided legal services at all, those services were rendered to Goldan. The dissent believed there was an issue of material fact as to whether Plaintiff's legal malpractice claims were based upon or arose out of Daniels's capacity or status as an officer, director, shareholder or employee of Goldan, or out of his alleged acts in relation to a business entity to which he had a controlling interest. Id. at 7.
The decision in K2 Investment Group, LLC highlights the dangers that are attendant when a lawyer is involved in a transaction where he or she has a controlling interest in an entity that is a party to the transaction, or is an officer or director of the entity, and the need for clear evidence of whom the lawyer is and is not representing. Moreover, this decision illustrates how, by the use of carefully crafted pleadings, the plaintiff in the underlying matter may be able to limit the insurer's ability to invoke and apply the exclusions. Insurers should proceed cautiously when evaluating these types of claims and deciding whether to disclaim. With Civil Practice Law and Rules § 5601(a) providing American Guarantee an appeal as of right to the Court of Appeals, there may be further developments in the law regarding these exclusions.
If you require further information regarding the information presented in this Legal Alert and its impact on your organization, please contact any of the members of the Professional Liability Practice Area.