No Coverage For Bankruptcy Court Sanctions Motion Because of Untimely Notice and Motion Did Not Seek Award of “Damages”

Applying Indiana law, the United States District Court for the Northern District of Indiana has held that no coverage was available for a claim because the insured failed to give timely notice to the insurer and defended the claim before notifying the insurer.  Bowman, Heintz, Boscia & Vician, P.C. v. Valiant Ins. Co., 2014 WL 3818235 (N.D. Ind. Aug. 1, 2014).  In addition, the court held that no coverage was available for the claim, which sought sanctions for violating a bankruptcy stay, because it did not seek amounts constituting “damages” under a lawyers malpractice policy.

A named partner of the insured law firm became embroiled in litigation with a golf community in Florida.  After the golf community filed for bankruptcy, the named partner brought a class action lawsuit against the purported individual owner of the golf community for diversion of escrow funds, and the golf community’s bankruptcy counsel sent a letter demanding dismissal of the case because it violated the bankruptcy stay.  When the named partner refused to dismiss the case, the golf community filed a motion with the bankruptcy court to enforce the automatic stay and seeking sanctions.  Although it had not been served with the motion, the law firm hired counsel to oppose the motion and appear at the hearing concerning the applicability of the stay to the litigation.  The court granted the stay motion and set a hearing date on the request for sanctions.  Ten days before the sanctions hearing and seven months after the letter from the golf community’s counsel, the law firm tendered the sanctions motion to its legal malpractice insurer.  The insurer denied coverage for the motion because it sought the award of sanctions, which did not constitute “damages,” as defined under the policy.  The insurer later contended that the law firm provided untimely notice of the motion.  The insured filed suit seeking coverage for the defense of the stay motion and indemnity for the amounts awarded for violation of the stay.

The court held that no coverage was available under the policy for the bankruptcy motion because the law firm failed to provide timely notice to the insurer.  The policy required the insured to give notice “of the Insured’s receipt of any notice, advice, or threat, whether written or verbal, that any person or organization intends to hold the Insured responsible for any alleged breach of duty.”  The court held that, at the earliest (seven months before notice), the law firm was aware of a “notice, advice, or threat” when it received the letter from the golf community’s bankruptcy counsel and, at the latest (three months before notice), when the bankruptcy court granted the stay motion and set a hearing to determine whether sanctions would be awarded.  So, notice was not timely provided.

Because the insurer proved that notice was not timely made, the burden shifted to the insured under Indiana law to prove that the insurer had not been prejudiced by the delayed notice.  The court held that the law firm failed to offer evidence that the insurer was not prejudiced by the delayed notice.  First, the court rejected the insured’s argument that timely notice of previous litigation involving the golf community obviated the need for timely notice of the stay motion.  The court held that the previous litigation was not related to the stay motion.  Second, the court rejected the argument that the law firm was not required to provide notice because it did not know how the court would rule on the request to enforce the stay.  It reasoned that the notice provisions are triggered by any threat that the insured be held liable—not simply threats of liability that the insured believes are credible.  Finally, the court held that the law firm’s defense of the bankruptcy motion nullified its notice under Indiana law because undertaking the defense denied the insurer of its right to investigate and defend the claim.

In addition, the court held that no coverage was available under the policy for the motion because the only relief sought—monetary sanctions for violating the bankruptcy stay—did not constitute “damages” under the policy.  As defined in the policy, covered “damages” expressly did not include “sanctions.”  The court held that the insurer’s duty to defend was never triggered because the bankruptcy motion sought to recover only amounts constituting sanctions for the law firm’s willful violation of the bankruptcy stay.