Applying New York law, the United States District Court for the Southern District of New York has held that a judgment creditor of an insured that defaulted in an underlying action had no right to policy proceeds because the insured breached the policy by allowing a default judgment to be entered against it.  XL Specialty Ins. Co. v. Lakian, No. 14 Civ. 5225 (S.D.N.Y. Jan. 15, 2015).  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.  After instituting the interpleader action, a claimant moved to intervene in the interpleader action to assert its rights to policy proceeds as a judgment creditor of the named insured, which had failed to defend against claimant’s lawsuit and allowed a $2.5 million default judgment to be entered against it.  The insurer and interpleader defendants opposed the claimant’s motion to intervene.  They argued that the claimant, stepping into the shoes of the named insured, could not recover under the policy because the named insured had breached the policy by failing to defend against the claimant’s lawsuit and allowing a default judgment to be entered against it.

The court denied the claimant’s motion to intervene because the named insured violated numerous policy provisions by allowing a default judgment to be entered against it.  Because the claimant had no greater rights in the policy than the named insured, no coverage was available under the policy for the default judgment.  First, the court held that the insurer did not waive its coverage defenses when it filed the interpleader action and deposited the remaining policy limit into the registry of the court.  The court reasoned that claimant’s argument would produce an “absurd result . . . if the mere filing of an interpleader action prevented the Court from evaluating whether certain claims to fund proceeds are contractually barred or otherwise not cognizable as a matter of law.”

Second, the court held that claimant did not have a significant, protectable interest in the policy proceeds as a judgment creditor “standing in the shoes” of the named insured.  The court concluded that the named insured breached the policy by failing to fulfill its obligations under the policy to defend itself against claims, defaulted in the claimant’s lawsuit without obtaining the insurer’s consent, and increased the insurer’s exposure under the policy. Finally, the court held that the claimant did not have the right to institute a direct action against the insurer under N.Y. Insurance Law § 3420 because the claimant’s lawsuit did not involve injuries to persons or property.