Applying New York law, a New York appeals court has affirmed denial of a policyholder’s motion for summary judgment as premature, where questions of fact remain regarding the applicability of capacity and equity interests exclusions to claims against a policyholder attorney. Law Offices of Zachary R. Greenhill P.C., v. Liberty Ins. Underwriters, Inc., 128 A.D.3d 556 (N.Y. App. Div. May 21, 2015). In so doing, the court determined that the insurer did not breach its duty to defend by defending subject to a reservation of rights.

The insurer issued a lawyers professional liability insurance policy to the insured law firm. The policy included an exclusion precluding coverage for “any claim arising out of [the policyholder’s] services and/or capacity as . . . an officer, director, partner, trustee, manager operator, or employee of an organization other than that of the name insured . . . .” (Capacity Exclusion). The policy also provided that: (1) “[i]f a person insured under this policy owns, along with his or her spouse” a ten percent or greater equity interest in an organization and “simultaneously provides professional legal services with respect to such an organization,” the policy “will provide no coverage to that person for any claims that result therefrom”; and (2) “[i]f the collective equity interest of” the insureds in an organization, including spouses of insured persons, is at least thirty-five percent, “and any person simultaneously provides professional legal services with respect to such an organization, this policy will provide no coverage to any person insured or to the named insured for any claims that result therefrom” (Equity Interests Exclusion).

An insured attorney was a founding member of a company, which was organized to partner with a high school in China to operate a joint Chinese-American high school program. Per the company’s operating agreement, the attorney and his wife collectively held a 49% equity interest in the company; however, the company’s operating agreement was never executed. The insured attorney and his wife brought a contract action against the company and a company co-founder, seeking to enforce a partially executed consulting agreement and to recover consulting fees for various services. The defendants counterclaimed, alleging repudiation of the consulting agreement, legal malpractice, self-dealing and fraud. The parties settled the underlying contract action, and the insured sought coverage for the costs incurred in defending against the counterclaims.

After initially denying coverage based on the Capacity and Equity Interests Exclusions, the insurer agreed to defend the policyholder subject to a full reservation of rights. In its coverage letter, the insurer expressed its intent to investigate further the policyholder’s status as a company executive and to determine whether “he was wearing two hats – one as a solo practitioner and the other as negotiator and executive” for the company. The insured brought the present coverage action and moved for summary judgment.

The trial court denied the insured’s motion for summary judgment. In affirming the denial, the appellate court first rejected the insured’s assertions that the insurer’s reservation of rights constituted an “outright refusal to defend” and a breach of the policy. The court explained that a reservation of rights allows an insurer the flexibility of fulfilling its duty to provide a defense “while continuing to investigate the claim further.”

The court also held that the policyholder’s motion for summary judgment was “premature” because “no discovery had been conducted as to whether the allegations in the counterclaims fall within either or both exclusions to coverage.” The court characterized the malpractice counterclaim against the policyholder as a “hybrid”claim, in that the insured, a practicing attorney who was compensated by the company for his legal services, sought payment of consulting fees of a “nonlegal nature.” The court reasoned that the situation was precisely what the Capacity and Equity Interests Exclusions “seem to encompass” where the policyholder is “serving two masters: his client and himself.” Because the counterclaims contained “intertwined allegations” about the policyholder’s legal services to the company in which he apparently had a financial interest, the court found that, at a minimum, discovery is necessary on the issue of the policyholder’s ownership interests and whether they fall within the Equity Interests Exclusion.