Insurer Breaches Duty to Defend by Interpleading Limit

A California federal district court has held that an insurer did not properly interplead its remaining policy limits because the amount subject to competing claims was less than the total amount interpled. Doublevision Entm’t, LLC v. Navigators Spec. Ins. Co., 2015 WL 5821414 (N.D. Cal. Oct. 6, 2015). Further, because interpleading the remaining policy limits caused the carrier to cease funding defense of an underlying claim, the court determined that the insurer had breached its duty to defend.

The insureds, an escrow company and its principal, were sued by a number of customers for mishandled escrows. They tendered those suits under a “wasting limits” E&O policy, which began to pay for their defense. While the litigation was pending, other customers filed administrative complaints with the California Department of Corporations, which conducted an investigation and ultimately found a shortage of nearly $200,000 in the company’s accounts. The Department of Corporations later moved to appoint a receiver to liquidate and wind up the business, and the order on that motion granted the receiver the authority to receive “any insurance proceeds which may provide coverage for the shortage in any escrow accounts.”

The E&O policy stated that the insurer was “not obligated … to continue to defend any claim after the applicable limit of liability has been exhausted by the payment of damages or claim expenses … or after the [insurer] has deposited the remaining available limit of liability into a court of competent jurisdiction ….” Realizing that the various claims were likely to exhaust its policy limit, the insurer first attempted to tender the policy limits to the insureds, but it received a letter from an enforcement attorney at the Department of Corporations informing the insurer that doing so might violate the order appointing a receiver of the insured company, inasmuch as the shortage of nearly $200,000 had not yet been satisfied. The insurer then filed a complaint for interpleader and deposited the balance of the policy limit, or nearly $500,000, into the registry of the court. The insurer did not name any of the private claimants as parties to the interpleader suit, however, and it instead named only the company insured and the Department of Corporations. (An amended complaint later added the individual insured and the receiver as defendants.) In the interim, the insurer ceased payment of fees for the insureds’ defense counsel, and their counsel withdrew shortly before trial was scheduled to commence.

The private suits were later settled with the interpleader funds, with the exception of one case. In that case, the plaintiff prevailed against the insureds, obtaining a judgment in excess of the insureds’ policy limit. The plaintiff subsequently took an assignment of the insureds’ claims against their insurer and brought suit against the insurer based on its alleged breach of the duty to defend. Pursuant to a Rule 50 motion, the trial court held that the insurer breached its duty to defend by interpleading the full policy limit (and ceasing to defend the insureds) rather than simply interpleading the nearly $200,000 at issue between the insureds and the Department of Corporations. The court later entered judgment against the insurer.

The insurer subsequently moved for judgment as a matter of law in its favor, asserting that the insureds had no claim against it to assign. The court rejected that motion, concluding that the prior ruling properly held that the insurer breached the duty to defend. In so ruling, the court stated that the policy “should be read as erasing the duty to defend only to the actual extent that conflicting claims are pending (and identified in the interpleader complaint).” Here, the court noted, the conflicting claims identified in the complaint—those asserted by the receiver and the Department of Corporations—were less than $200,000, so it was an error for the insurer to deposit the policy limit (which totaled close to $500,000 by that time) with the court. The court ruled that the insurer breached its duty to defend by failing “to keep the oxygen flowing” to the insured in the form of defense costs in connection with the other claims. The court also rejected the insurer’s argument that it later “cured” defects associated with its failure to name the private claimants in its interpleader action, noting that the insurer’s initial breach “left its insureds gasping for air for months, through the start” of the trial that ultimately led to the excess judgment against them. As such, the court determined that the insurer had not properly exhausted its policy limit, and thus that it breached its duty to defend by refusing to pay additional defense expenses after it had improperly impleaded its policy limit in the interpleader action.