Judgment Creditor Not Entitled to Policy Proceeds Where Insured Defaulted Without Insurer’s Consent

The United States District Court for the Southern District of New York, applying New York law, has held that two judgment creditors of an insured were not entitled to insurance policy proceeds where the insured had breached the terms of the policy by allowing a default judgment to be entered against it.  XL Specialty Ins. Co., v. Lakian, 2017 WL 1063451 (S.D.N.Y. March 20, 2017).  The court further held that the insurer had not waived its policy defenses by writing a letter to the broker informing it of the insured’s duty to defend the action or by filing an interpleader action without naming the judgment creditors.  The court also concluded that a third judgment creditor for an insured person had no rights to the policy because it had no claim under the policy at the time the interpleader action was filed, and because the policy was not property of the insured person.  Wiley Rein represents the insurer.

A professional liability insurer filed an interpleader action against two insured persons and a law firm retained by the insureds because the insurer was faced with competing demands in excess of remaining policy limits.  Several other law firms retained by the insureds and three judgment creditors were permitted to intervene.  The demands arose from two underlying suits, brought by investors against the named insured investment fund and its officers, alleging fraudulent inducement, breach of fiduciary duty, and misuse of the invested funds.

Two judgment creditor investors, who had obtained a default judgment against the investment fund in an underlying action, sought summary judgment that they were entitled to the interpleaded funds.  The insurer had determined that the judgment creditors were not entitled to coverage because the investment fund, which had allowed a default judgment to be entered against it, had breached the policy by failing to fulfill its duty to defend the claim and by admitting liability without the insurer’s consent.  The court rejected the judgment creditors’ argument that the insurer had a duty to take action to avoid the default, because the policy imposed no duty to defend on the insurer and instead imposed an explicit duty to defend on the insured.  The court also held that the fund’s default was tantamount to an admission of liability, in violation of the policy provision requiring the insured to seek consent prior to settling or admitting liability.  The court also concluded that the insurer had not waived its defenses by sending a letter to the insured’s broker informing it of the motion for default and the insured’s duty to defend, because the letter had explicitly reserved all of the insurer’s rights.  The court further determined that the insurer’s filing of the interpleader action without pleading the lack of coverage for the named insured also did not constitute waiver, as the insurer had attached the policy and interpleaded as defendants all persons or entities who had, to date, sought coverage under the policy, which the insured investment fund and its judgment creditors had not done.  As a result, the court concluded, the judgment creditors were not entitled to coverage.

Another investment fund also intervened, as a judgment creditor of one of the insured persons arising from a separate underlying action.  The court noted that the intervening fund had no claim under the policy at the time the interpleader action was filed because it did not yet have a judgment against the insured person.  The court concluded that, because courts determine the rights of interpleader parties on the basis of the facts extant at the time the action was commenced, the fund’s claim was barred. The fund also could not attach the insured person’s interest in the interpleaded policy proceeds because the insured person was not entitled to recover any portion of the interpleaded funds, and therefore any benefits to him under the policy were not his property.

Finally, the court determined that, because it had dismissed the judgment creditors, the remaining interpleader defendants were entitled to disbursement of the interpleaded funds as agreed among them.