D&O insurance policyholders sometimes bridle when the insurers take steps to try to rein in burgeoning defense expense. In that situation, the D&O insurers will often try to remind the policyholder that because defense expense erodes the limit of liability, it is in everyone’s interest for defense expense to be monitored closely. An unusual coverage action in the Western District of New York reversed the usual concerns about insurer defense cost control. The policyholder sued its D&O insurer for breach of contract, bad faith, and intentional infliction of emotional distress not for failing to pay defense costs or full defense costs, but rather for allowing the policyholder’s defense expenses incurred in an underlying criminal action to exhaust the applicable limit of liability. While it is hardly a surprise that a court concluded that an insurer that paid out its full limits cannot be held liable for breach of contract – much less bad faith or infliction of emotional distress –there are still a number of interesting aspects to this dispute and to the court’s ruling.
Marc Irwin Korn is the sole owner of Senior Associates LLC and a number of other businesses operating nursing homes in and around Buffalo, New York. In December 2011, Korn was indicted on several criminal charges, including wire fraud and making a false statement.
Korn submitted the criminal matter to the D&O insurer of Senior Associates. The insurer accepted the defense subject to a reservation of its rights under the policy. At that time and in several subsequent communications, the insurer reminded Korn that defense expense erodes the limit of liability.
After the prosecutors filed a superseding indictment against Korn adding several additional criminal charges, the insurer affirmed that it would continue to provide Korn with a defense. However because it was determined that the insurer’s regular panel counsel could not handle the criminal matter, the insurer agreed that a non-panel attorney would be retained to provide the defense. Korn requested the insurer’s assistance in obtaining criminal representation and recommended several criminal defense lawyers, noting again that defense costs would erode the limits of liability. Korn selected one of the law firm’s the insurer recommended.
The insurer made periodic payments to the defense counsel Korn selected. The insurer contended in the subsequent insurance coverage action that at the time of each payment, the insurer advised Korn of the amount remaining of the limits of liability available. An April 2015 defense expense payment exhausted the remaining limit of liability.
In December 2016, Korn filed an action against the insurer alleging breach of fiduciary duty, breach of contract, bad faith, and intentional infliction of emotional distress. The insurer filed a motion for summary judgment.
In November 2018, Korn ultimately resolved the criminal matter by pleading guilty to two criminal misdemeanors.
The September 10, 2019 Opinion
In a September 10, 2019 Opinion, Judge Christina Reiss, applying New York law, granted the insurer’s motion for summary judgment.
Korn’s had first claimed that the insurer had breached its fiduciary duty by its failure to monitor his criminal defense attorneys and failing to keep track of the legal fees. Judge Reiss rejected this claim, holding that New York does not recognize a fiduciary duty or vicarious liability based on the acts or omissions of outside counsel retained by an insurance company for its insured’s defense. While there are rare exceptions when a special relationship between the parties may give rise to a fiduciary duty, the court found that the circumstances justifying the exception were not present here, even if, as Korn alleged, the insurer had “brokered” the attorney client relationship.
Korn also alleged that the insurer had breached in the insurance contract by failing to insure that his defense in the underlying criminal action progressed at the proper rate. He also alleged that the insurer breach the insurance contract by failing to follow its own defense counsel guidelines. Finally, he alleged that the insurer breached the contract by adding attorneys and law firms to the defense without his approval.
Judge Reiss granted the insurer’s motion for summary judgment on all three of these issues, holding first that the plaintiff had failed to establish a contractual obligation under the policy to ensure a “reasonable rate of progression’ so as to avoid exhaustion of the policy limit. Similarly, Judge Reiss said that the plaintiff had identified no obligation in the policy requiring the insurer to follow its own guidelines for Korn’s benefit. Moreover, Judge Reiss added, even if Korn could establish such an obligation, he had failed to proffer any evidence that it had been breached.
Judge Reiss also granted the insurer’s motion for summary judgment on the breach of contract allegation relating to the staffing of the defense. Plaintiff had argued that the insurer had breached the contract by allowing three firms to bill time on the defense – although he did also admit that he did request that additional legal personnel outside of the selected law firm be added to his legal team. Judge Reiss noted that the policy gave the insurer the “sole right and duty to select counsel for the defense, and so it is “immaterial” whether the insurer or Korn or both participated in the staffing of Korn’s criminal defense.
Finally, Judge Reiss rejected Korn’s bad faith and emotional distress claims. Judge Reiss said that the plaintiff had failed to establish any legal duty separate from the insurer’s duties under the contract, adding that in any event Korn had failed to proffer any evidence that the insurer had failed to act in good faith. In rejecting the emotional distress claim, Judge Reiss noted that under New York law, emotion distress generally is not compensable in a breach of contract, and that no legal duty independent of the contract had been established.
As someone who spends far too much of my time wrestling with insurers trying to get them to step up and pay their policyholders’ defense expense, it is somewhat startling to see a policyholder claiming that an insurer breached its policy and acted in bad faith by paying out its full policy limit in defense. And not just in defense, but in defense of a criminal matter.
The underlying facts certainly do underscore the fact that because the payment of defense expense erodes the limit of liability and that it is in both the policyholder’s interest and the insurer’s interest for defense expense to be controlled. However, the issue of defense cost control usually comes up in a far different context, usually where the policyholder (or the policyholder’s counsel) argues that the insurer’s efforts to control defense expense are undermining the defense of the claim or represents bad faith.
So it is quite ironic that in this case that policyholder alleged that the insurer’s failure to control defense expenses breached the contract – indeed, not only breached the contract but constituted bad faith and inflicted emotional distress on the policyholder. Usually it is the other way around, the policyholder is alleging that it is the attempt to control defense costs or to make defense counsel adhere to counsel guidelines that is a breach of the contract or represents bad faith.
While one important underlying message of this case is the mutual interest of the policyholder and the insurer in managing defense expense, there is another important lesson — which is that the enormous expense that the defense of a serious claim can entail is an important consideration to be taken into account when the time comes for the policyholder to decide how much insurance they want to buy. For anyone who has never been involved in a serious D&O claim, it can be hard to imagine how fast defense expenses can mount.
All too often, D&O insurance buyers decide to buy the minimum amount of insurance; as this case shows, minimal amounts of insurance may be insufficient to protect a policyholder in the event of a serious claim (in this case, the policy’s limit of liability was $1 million). Many insurance buyers do not want to hear that if they want to be fully protected against a serious claim, they need to buy additional limits of liability; a frequent perception is that an insurance advisor’s plea that the policyholder consider buying additional limits is nothing more than an incentivized actor’s bid to try and sell more insurance. As this case demonstrates, additional limits of liability could prove indispensable in the event of a serious claim.