Good Faith but Mistaken Denial of Coverage Does Not Support Bad Faith Claim or Consequential or Punitive Damages

A New York federal district court, applying New York law, has held that a manager of a restaurant venture may not pursue a bad faith claim against his directors and officers liability insurer where the insurer’s coverage denial, while ultimately incorrect, was made in good faith, nor can he recover consequential or punitive damages in excess of the policy limits on his breach of contract claim.  Scottsdale Ins. Co. v. McGrath, 2021 WL 3077578 (S.D.N.Y. July 19, 2021).

A restaurant venture failed to meet its funding obligations and ultimately filed for bankruptcy, which led to a number of claims including against the various entities involved in the venture and the individual manager.  The parent company of one of the entities in the restaurant venture provided notice to its directors and officers insurer, which denied coverage on the grounds that the entities and individuals against whom the claims were made were not insureds under the parent company’s policy.  Several years later, the individual restaurant manager tendered a settlement demand to the parent company’s insurer, contending that the manager was entitled to coverage as a director of a subsidiary of the parent company.  The insurer again denied coverage and then filed a declaratory judgment action. 

On the insurer’s previous motion for summary judgment, the court had held that the manager was an insured under the parent company’s policy.  Following this ruling, the insurer moved for partial summary judgment with respect to the manager’s counterclaims for bad faith and for consequential and punitive damages exceeding the policy limits.

The court granted summary judgment to the insurer on the bad faith counterclaim.  The court held that the manager could not sustain a bad faith claim based solely on the insurer’s “good faith but mistaken interpretation” of the policy, noting that, although the court ultimately rejected the insurer’s coverage position, its arguments were “far from unreasonable.”  Nor could the manager sustain a claim for bad faith failure to settle because the insurer never exercised exclusive control over the claim against the manager, “an essential element of any claim for bad faith failure to settle.”  To the contrary, the manager remained free to settle the claim against him and seek indemnification from the insurer.

The court also granted summary judgment to the insurer with respect to the manager’s prayer for consequential and punitive damages in excess of the policy limits based on his breach of contract claim.  The court held that, at least in the context of a third-party liability policy providing for advancement of defense costs and indemnification up to a specified policy limit, an insured may not recover amounts in excess of the policy limits on a breach of contract claim.   

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