Insurer’s Failure to Defend Sanctions Proceeding not Bad Faith

POST v. ST. PAUL TRAVELERS INS. CO. (3rd Circuit, (PA) July 31, 2012)

In an attorney’s suit against his legal malpractice insurer claiming, inter alia, insurance bad faith and breach of contract, the district court’s grant of summary judgment in defendant’s favor on the bad faith claim was affirmed, because the insurer performed an adequate investigation, and the Policy’s sanctions exclusion provided a reasonable basis for denying coverage. Therefore, the insurer did not act in bad faith.

The law firm was insured under a $10 million malpractice policy. Post and another attorney at the firm of Post & Schell, P.C. allegedly improperly redacted information from documents which were produced by their client in a medical malpractice suit. Unfortunately, the discovery misconduct came up during testimony at trial. The client immediately fired the attorney, but was concerned what the jury would think and that it could possibly lead to punitive damages exposure. The client quickly settled with the underlying plaintiffs for its full liability limit, $11 million.

The client then retained counsel to bring a malpractice suit against the attorney. Malpractice counsel asked the attorney to put his carrier on notice of the claim, but he did not immediately file the malpractice suit. The underlying plaintiffs, and not the client, then commenced a sanctions proceeding against the attorney and his firm for the improper redactions produced during discovery. The attorney then tendered a claim for defense and indemnity for the sanctions proceeding under his E&O policy. The attorney urged the carrier that although the action was styled as a sanctions proceeding, the complaint was in actuality a claim for legal malpractice, and further, any facts developed in the sanctions proceeding would likely be used against him in a subsequent malpractice suit.

The insurer denied coverage based upon the policy’s exclusion for “civil or criminal fines, forfeitures, penalties, or sanctions” as well as the ground that under the terms of the policy, a covered “claim” is defined in the policy as a “demand that seeks damages,” and sanctions are not “damages.” However, when the client intervened, the insurer offered to contribute a small amount to defense costs and even to contribute to mediation under a reservation of rights. This sparked the attorney to bring a declaratory action seeking to recover defense and indemnity costs and statutory damages for the insurers alleged bad faith denial.

According to the court, there was no “dishonest purpose” behind the insurer’s denial. Specifically, the court found that: “Travelers did not frivolously decline to provide a defense to Post; rather, after an investigation and retention of outside counsel, Travelers reasonably concluded that the sanctions exclusion in the policy applied to Post’s claim and denied coverage. Even if Travelers’ claims-handling was notideal, there is no evidence in the record … to indicate that Travelers’ purported handling of Post’s claim was motivated by dishonest purpose or ill will.”

Impact: Standards governing bad faith vary across jurisdictions. Generally, errors or negligence in handling a claim is insufficient to give rise to a bad faith claim. In this case, while the court acknowledged potential problems in handling the claim, the policyholder could not assert a valid a bad faith claim absent some degree of intent or malice on the part of the insurer.