Utah Federal Court Applies Fairly Debatable Defense to Third-Party Bad Faith Claim;

Finds Utah Law Does Not Prohibit Withdrawal of Defense Under ROR

Contact: Richard A. Vazquez

In Allegis Investment Services, LLC v. Arthur J. Gallagher & Co., 2019 WL 1002364, –F.Supp.3d–, (D. Utah Mar. 1. 2019) Utah Senior Federal District Court Judge Dale A. Kimball granted Indian Harbor Insurance Company’s motion for summary judgment on policyholder Allegis Investment Services’ claims for breach of the duty to defend, duty to indemnify, and implied duty of good faith and fair dealing.

The Court found that Indian Harbor met its burden to “demonstrate that none of the allegations of the underlying claims are potentially covered or that a policy exclusion conclusively applies to exclude all potential for such coverage.” Indian Harbor did so by showing that the clear language of the Options Exclusion in its E & O Policy barred coverage for underlying investors’ suits and arbitration proceedings against Allegis because Allegis’ August 2015 trade, the subject of those underlying actions, did not involve fully covered put options.

Indian Harbor initially undertook defense of the underlying actions under a reservation of rights, then withdrew from defense upon concluding after investigation that no coverage existed. Allegis argued that it was a breach of contract for Indian Harbor to undertake the defense and then subsequently abandon it. Judge Kimball disagreed.

Although no Utah appellate courts have ruled that an insurer must continue its defense until a court rules there is no coverage, Allegis requested that the Court adopt the law of other states which impose that duty. The Court found that under Utah law, Allegis cannot use estoppel to extend the terms of the insurance contract: “The Utah Supreme Court has stated that where the insurer disclaims and withdraws prior to final judgment …. the insurer is not estopped … without proof by competent evidence that the insured was actually prejudiced by its conduct.” The Court found that Allegis did not demonstrate any prejudice because the timing of Indian Harbor’s denial of coverage did not deprive Allegis “of an opportunity to prepare an adequate defense before trial or in the alternative to effect a settlement.” Utah law therefore did not require Indian Harbor to continue its defense until a court rules that there is no coverage without proof of prejudice.

Further, because the Policy did not cover the underlying investor claims against Allegis, the Court found that Allegis’ bad faith claim and request for punitive damages necessarily failed as well. In doing so, it applied the “fairly debatable” standard to Allegis’ third-party insurance bad faith claim. The Court stated that “Utah’s standards for imposing liability on an insurer for a bad faith denial of coverage are clear. If an insurer acts reasonably in denying a claim, then the insurer did not contravene the covenant [of good faith and fair dealing. The denial of a claim is reasonable if the insured’s claim is fairly debatable.”

The Court found that “Indian Harbor’s denial of coverage based on the Options Trading Exclusion was not only reasonable, it was correct. Allegis’ claim that the traded puts were purportedly covered because they were allegedly cash-secured is unreasonable. The absence of coverage precludes Allegis’ bad faith denial of coverage claim as a matter of law. Moreover, even if Indian Harbor and the court are both wrong on that issue, the issue is at least fairly debatable and cannot be the basis of a bad faith claim.”

This is notable, because the Utah Supreme Court has within the past two years stated that the application of the “fairly debatable” defense to a third-party bad faith claim remains an open question in Utah.

The Court also found that Allegis’ bad faith claim based on Indian Harbor’s alleged failure to conduct a full and reasonable investigation also failed. Allegis claimed that Indian Harbor did not conduct a full investigation, but pointed to no facts that Indian Harbor should have discovered that would have provided a basis for coverage. Also, in response to Indian Harbor’s denial letter, Allegis did not submit any additional information or try to contradict any facts regarding the trade despite Indian Harbor’s invitation to submit any additional information. Allegis was therefore estopped from claiming that the issue was not fully investigated after the fact.

Our insurance coverage and bad faith lawyers are ready to help.  For more information about the services SCM provides in this area, contact Richard A. Vazquez.