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November 19, 1986


The opinion of the court was delivered by: BRIEANT


Brieant, Chief J.

 The parties have each moved for summary judgment in this diversity action involving the construction of an insurance contract. Plaintiff Board of Education, Yonkers City School District (hereafter "the Board"), is one of the defendants in a school and housing segregation suit instituted by the United States Department of Justice in December 1980. (United States of America v. Yonkers Board of Education, City of Yonkers, and Yonkers Community Development Agency, 80 Civ. 6761 (LBS), hereafter "the underlying lawsuit"). Defendant Continental Casualty Company (hereafter "Continental"), a member of the CNA Insurance Group, is the Board's liability insurance carrier. Disputed in this action is whether Continental must indemnify the Board for the cost of defending the segregation suit.


 On December 1, 1980, subsequent to a long investigation, the Department of Justice commenced an action against the City of Yonkers, the Yonkers Community Development Agency and the Yonkers Board of Education for intentionally creating and maintaining racial segregation in the City's housing and schools. *fn1" The complaint also alleged area-wide discrimination by race and breach of contractual assurances made by the Board in return for its continuing receipt of federal assistance.

 On November 20, 1985, after a trial that lasted almost 100 days, Judge Sand of this Court found that both the City and the Board had engaged in intentionally segregative practices. United States of America v. Yonkers Board of Education, 624 F. Supp. 1276 (S.D.N.Y. 1985). In a 589 page decision, Judge Sand found that the Board had rendered "individual, deliberately segregative school opening, closing, and attendance zone decisions," 624 F. Supp. at 1526; had exhibited "segregative intent with current segregative impact . . . in the assignment of faculty and administrative staff," 624 F. Supp. at 1527; had steered minority students into vocational educational programs "followed by the continued adherence to the knowingly segregative policies . . . operat[ing] to deprive minorities (particularly blacks) of equal educational opportunities on the secondary school level," 624 F. Supp. at 1528; had reinforced discriminatory community attitudes toward minorities in the operation of the Special Education program, 624 F. Supp. at 1528; and had rejected or failed to implement school desegregation plans. 624 F. Supp. at 1529.

 Judge Sand found that "[t]he Yonkers public schools not only are racially segregated but also are unequal in the quality of educational opportunity afforded to students in these schools." 624 F. Supp. at 1530. He noted that while school authorities acknowledged the disparities in educational opportunity, they repeatedly refused to implement comprehensive desegregative measures, a decision that was "racially influenced." 624 F. Supp. at 1531. Judge Sand found the Board and the City liable for the existence of an unconstitutionally segregated school system. He found the City additionally liable for systematically segregated public housing which aggravated the school segregation.

 In the months following the finding of liability, Judge Sand conducted hearings on the action's remedy phase and supervised negotiations among the parties. On May 13, 1986, Judge Sand entered a final order for desegregation of the Yonkers public school system, 635 F. Supp. 1538 (S.D.N.Y. 1986); and on May 28, 1986, he entered a final housing remedy order. 635 F. Supp. 1577 (S.D.N.Y. 1986). In both instances, the court retained jurisdiction to enforce the terms of the orders. Notices of appeal from the remedy orders have been filed and are pending in the Court of Appeals. In addition, local homeowners have filed a notice of appeal from denial of participation as proposed intervenors concerning a housing order issued on June 26, 1986.

 Throughout the underlying lawsuit, the Board has maintained contact with its liability insurer Continental and in July 1985, formally demanded reimbursement for nearly three million dollars in legal fees and expenses. *fn2" Continental ultimately refused to pay and as a result the Board instituted this suit.


 The instant action arises out of two insurance policies, issued to the Board by Continental, in effect during the pendency of the Department of Justice lawsuit described above. Complaint PP 6-9. The policies are designated "Board of Education Liability Including School District Reimbursement" or "BEL" policies. The Board alleges in its complaint that the policies provide coverage for the cost of defending against charges of race discrimination. The Board primarily relies on "clear and unambiguous" language in the policies and on a "coverage letter" Continental sent in response to notice from the Board of the commencement of the underlying lawsuit, indicating that it would indemnify defense costs.

 Continental contends that the policies expressly exclude coverage of any loss arising out of charges of intentional segregation, and that its letter does not work an estoppel and is not evidence of coverage, but rather constitutes a "reservation of rights."

 Continental has been writing liability insurance for the Board since 1975. It does not insure the City of Yonkers or any other defendant in the underlying lawsuit. The first policy in dispute here went into effect in May 1978 for a period extending to May 1981 (BEL 116 60 511). The second, "successor" policy covered the period from May 1981 to May 1984 (BEL 006 88 36 05). It contains all the language and provisions considered relevant by the parties in the first policy. The stated limit of liability on the successor policy is $5,000,000.00, as opposed to $3,000,000.00 on the first policy. *fn3"

 Subsequent to the filing of the complaint in the underlying lawsuit on December 1, 1980, the Board and Continental were parties to numerous communications, the existence and contents of which cannot be disputed, regarding insurance coverage. By letter dated December 4, 1980, the Board sent the complaint in the underlying lawsuit to its insurance broker, Marsh and MacLennan. Marsh and MacLennan in turn forwarded the complaint to Continental on December 10, 1980, requesting Continental's "position as it pertains to the defense of this matter." By letter dated December 23, 1980, the Manager of Professional Liability Claims for Continental acknowledged receipt of the notice, and indicated that the matter was being referred to the claims office and that the responsibility for the assignment of an attorney rested with the Board. Apparently finding no satisfactory counsel in this district, the Board thereafter retained the Detroit law firm of Butzel, Long, Gust, Klein & Van Zile.

 By letter dated January 7, 1981, a Continental claims supervisor advised the Board's broker, Marsh and MacLennan, that

 "We are presently examining the allegations of the complaint with our home office and will advise you more fully concerning our position on coverage in the very near future."

 The claims supervisor then sent a memorandum to a Continental "Home Office Analyst" on January 16, 1981, requesting advice as to "any particular language to recite on this type of case" and noting that "[i]t will be an expensive case to defend obviously." On January 20, 1981, the Home Office Analyst responded by directing the claims supervisor to

 "Include on reservation

 1. Our coverage is only for named 'Board of Ed' not co-defts [sic].

 2. Policy will not respond for costs of implementing desegregation plan.

 3. New York State Provision -- Exclu [sic] IV(b)(5) 'for injury arising out of discrimination.'

 4. That policy will respond for defense costs. " [Emphasis added].

 On April 10, 1981, the Continental claims supervisor sent the Board what it terms a "coverage letter" and what Continental terms a "reservation of rights." As directed by the Home Office Analyst, the letter recites the names of those entities to which coverage is provided and states:

 "The cost of investigating and defending legal actions are payable as part of loss under this policy. The company does provide the defense, and the assureds must retain their own attorney for the defense of the case."

 The letter then requests from counsel retained by the Board information on defense plans and fee arrangements. It continues:

 "Although our policy will respond for defense and investigative costs in connection with this litigation, it is subject to a retention of $2500, and further policy will not respond for any expenses or costs which may become the responsibility of the Yonkers Board of Education for implementing a desegregation plan."

 The letter concludes by advising the Board to review the policy's "clarification endorsement" and "New York State Provision."

 Subsequent to this exchange, the Board periodically communicated with Continental as to the progress of the underlying lawsuit and the extent of defense costs. Continental's "file activity sheet," a diary of actions taken with respect to the Board's claim, reflects numerous meetings and telephone conversations with the Board, the Board's insurance broker, and the Butzel law firm. During the pendency of the underlying lawsuit, Continental received written and oral status reports and at least two fee summaries. Continental established a $20,000 reserve fund to cover defense costs, which reserve was raised to $250,000 in January 1983, then recommended to be raised to $2,000,000 in May 1983 and $3,000,000 in October 1983. One unsuccessful attempt at obtaining reimbursement from Continental was made in early 1984 by Marsh and MacLennan, according to its "underwriting file." Continental has not made any payment to the Board.

 By letter dated July 29, 1985, the Board's then Superintendent of Schools, Joan Raymond, formally demanded reimbursement of defense costs with interest. Continental responded by requesting an audit of all bills and expenses paid by the Board. Subsequent to the audit, by letter dated October 15, 1985, Continental disclaimed liability for "any coverage and/or payment under the policy." On October 28, 1985, the Board served on Continental a verified complaint alleging breach of contract for payment of legal fees totalling 3.2 million dollars, on its face a somewhat surprising amount considering that legal services rendered by the Butzel law firm extended to all defendants in the underlying lawsuit, but only the Board is insured by Continental. The Board also requests declaratory relief as to the ...

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