Insurer Cannot Invoke Arbitration Clause Following Breach of Duty to Defend

A Montana federal district court has held that an insurer was estopped from invoking a policy’s arbitration clause where the insurer had breached its duty to defend by improperly relying on a creditor exclusion in the policy.  Am. Trucking & Transp. Ins. Co. v. Nelson, 2018 WL 1902700 (D. Mont. Apr. 20, 2018).

A dispute arose between a risk retention group and one of its member insureds.  When the insured began experiencing financial difficulty, the risk retention group took over handling all open liability claims within the insured’s deductible, and thereafter determined that the insured had failed to satisfy its obligations under the group’s shareholder agreement.  When the insured later filed for Chapter 11 bankruptcy, the risk retention group filed two unsecured claims in the bankruptcy proceeding and filed suit against the insured’s directors and officers.  After the risk retention group settled the civil lawsuit with the insured individuals pursuant to a stipulated judgment, it sought coverage for the settlement from the insured’s D&O carrier.  The carrier denied defense and indemnity coverage based on a creditor exclusion that precluded coverage for claims by any secured or unsecured creditor of the company.  In the later coverage litigation, the insurer sought to compel arbitration under the D&O policy’s alternative dispute resolution provision.

The court first determined that the D&O policy contained a valid arbitration clause, which was not abrogated under Montana law.  However, the court then held that the insurer had not proven that the creditor exclusion applied because although the risk retention group admitted to holding unsecured claims in the bankruptcy proceeding, the parties disputed the meaning of the term “creditor” as used in the D&O policy exclusion, and the court decided that it could not determine as a matter of law whether the risk retention group’s claim fell within the exclusion.  The insurer therefore had a duty to defend.  The court concluded that, “under the facts of this case,” the insurer “should have initially offered a defense to its Insureds under a reservation of rights and then filed a declaratory judgment action regarding coverage. Because [the insurer] failed to provide a defense, Montana law is clear that [the insurer] has lost its right to invoke insurance contract defenses, including the right to arbitrate.”