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Commerce and Industry Insurance Co. v. U.S. Bank National Association

September 3, 2008


The opinion of the court was delivered by: John G. Koeltl, District Judge


The plaintiffs, Commerce and Industry Insurance Company ("C&I") and American International Specialty Lines Insurance Company ("AISLIC"), filed this action seeking a declaratory judgment on their obligations and liabilities under six commercial real estate insurance policies with regard to sixty-four claims made by the defendant, U.S. Bank National Association ("U.S. Bank"), as indenture trustee for the registered holders of FMAC Loan Receivables Trusts 1997-B, 1998-B, 1998-C, 1998-D, and 2000-A, under those policies. Jurisdiction is based on diversity of citizenship pursuant to 28 U.S.C. § 1332. The defendant filed counterclaims for (1) breach of contract and (2) bad faith refusal to pay. The plaintiffs, pursuant to Federal Rule of Civil Procedure 12(b)(6), move to dismiss the defendant's counterclaim for bad faith refusal to pay, as well as the associated request for punitive damages and attorneys' fees that are based on the bad faith claim.


In deciding a motion to dismiss a counterclaim pursuant to Rule 12(b)(6), the allegations in the claimant's pleadings are accepted as true and all reasonable inferences must be drawn in the claimant's favor. McCarthy v. Dun & Bradstreet Corp., 482 F.3d 184, 191 (2d Cir. 2007); Arista Records LLC v. Lime Group LLC, No. 06 Civ. 5936, 2007 WL 4267190, at *4-*5 (S.D.N.Y. Dec. 3, 2007). The Court should not dismiss the counterclaim if the counter-plaintiff has stated "enough facts to state a claim to relief that is plausible on its face." Twombly v. Bell Atlantic Corp., 127 S.Ct. 1955, 1974 (2007). See Katz v. Image Innovations Holdings, Inc., No. 06 Civ. 3707, 2008 WL 762101, at *2 (S.D.N.Y. March 24, 2008).

The Court may consider documents that are referenced in the counterclaim, documents that the counter-plaintiff relied on in bringing suit and that are either in the plaintiff's possession or that the plaintiff knew of when bringing suit, or matters of which judicial notice may be taken. Chambers v. Time Warner, Inc., 282 F.3d 147, 153 (2d Cir. 2002); see also Taylor v. Vermont Dep't of Educ., 313 F.3d 768, 776 (2d Cir. 2002); Kramer v. Time Warner, Inc., 937 F.2d 767, 773 (2d Cir. 1991); Brass v. Am. Film Techs., Inc., 987 F.2d 142, 150 (2d Cir. 1993); Cortec Indus., Inc. v. Sum Holding L.P., 949 F.2d 42, 47-48 (2d Cir. 1991); VTech Holdings Ltd. v. Lucent Techs., Inc., 172 F.Supp.2d 435, 437 (S.D.N.Y. 2001).


The following facts are accepted as true for the purposes of this motion.

In the late 1990's, the Franchise Mortgage Acceptance Company LLC ("FMAC") made various loans that were secured by commercial real estate. Most of the properties, if not all, have underground petroleum storage tanks. FMAC then assigned its interest in these loans, as well as the related deeds securing the debt, to various trusts of FMAC Loan Receivables Trusts (the "Trusts"). U.S. Bank, the defendant, is the indenture trustee of the Trusts. (Def.'s Countercl. ¶ 6). The loans are secured by the "Insured Properties." (Def.'s Countercl. ¶ 10).

The Trusts faced a risk that the borrowers would default on the loans. Additionally, the Insured Properties might develop on-site pollution conditions as a result of the underground petroleum tanks, which could negatively impact the value of the collateral securing the loans. In light of these risks, the Trusts purchased six Secured Creditor Impaired Property ("SCIP") insurance policies issued by the plaintiffs. Among the purchased policies were the policies numbered 5295738, 5295859, 5295865, 7788373, 7788374 (the "C&I Policies") and 8195202 (the "AISLIC Policy")(collectively, the "Policies"). (Def.'s Countercl. ¶¶ 6-7).

The Policies insure U.S. Bank against losses that result from borrowers defaulting on commercial real estate loans, where "On-Site Pollution Conditions" exist on the Insured Properties. (Def.'s Countercl. ¶ 8). Should the defendant incur losses as a result of a borrower's default on a commercial real estate loan that is secured by an Insured Property containing an onsite pollution condition, the Policies require the respective insurer to pay the lesser of the "Outstanding Balance" remaining on the loan, or the "Clean-Up Costs" associated with the on-site pollution conditions. (Id.) These insurance policies protect the defendant against financial losses arising from Insured Properties that it seeks to repossess in the event of borrower defaults, where the value of those properties is reduced by on-site pollution conditions.

The defendant has incurred substantial financial losses as a result of defaults by borrowers of commercial real estate loans, where pollution conditions were found on various properties that served as security for the defaulted commercial real estate loans. (Def.'s Countercl. ¶¶ 9-11). The various properties at issue are covered either by the C&I Policies or the AISLIC Policy. (Def.'s Countercl. ¶ 10). The defendant has provided the plaintiffs with timely notice of the details of its claims, and the factual conditions required by the Policies have been met and/or waived, but the plaintiffs have not paid a substantial portion of the defendant's "Losses" under the Policies. (Def.'s Countercl. ¶¶ 12, 13, 15).

The plaintiffs have brought this action for declaratory relief, pursuant to 28 U.S.C. § 2201, seeking a declaration as to the scope of their liability, if any, under the Policies, as well as to any recovery for which they might be entitled with regard to any payments they have already made to the defendant, in connection with sixty-four claims under the Policies. (Second Am. Compl. ("SAC") ¶¶ 52, 55). Although the AISLIC policy contains an arbitration agreement, the parties have agreed to waive their rights under that agreement, choosing instead to litigate the claims brought under the AISLIC policy before this Court. (SAC ¶ 12; Answer ¶ 12.) In its Answer, the defendant has asserted counterclaims for breach of contract, as well as bad faith refusal to pay. (Def.'s Countercl. ¶¶ 16-29). In connection with the claim for bad faith refusal to pay, the defendant seeks punitive damages, attorneys' fees, litigation expenses, and pre-judgment interest. (Def.'s Countercl. ¶¶ 28, 29.) The plaintiffs have moved to dismiss the counterclaim for bad faith refusal to pay.


The plaintiffs' motion to dismiss depends on the law that governs the bad faith claim. The plaintiffs' assertion that the bad faith claim should be dismissed depends on the application of New York law to that claim. The defendant disputes that New York law applies to the bad faith claim.

If New York law governs the defendant's claim for bad faith refusal to pay, the plaintiffs' motion to dismiss that counterclaim must be granted. Under New York law, "implicit in contracts of insurance is a covenant of good faith and fair dealing . . ." Bi-Economy Market, Inc. v. Harleysville Ins. Co. of New York, 10 N.Y.3d 187, 194 (2008) (citing New York Univ. v. Continental Ins. Co., 87 N.Y.2d 308, 318, 662 N.E.2d 763, 769 (1995)). As such, New York law views various bad faith claims against insurance carriers as "contractual in nature." New England Ins. Co. v. Healthcare Underwriters Mut. Ins. Co., 352 F.3d 599, 606 (2d Cir. 2003) (internal citations omitted). A "breach of [the implied duty of good faith] is merely a breach of the underlying contract." Sea Carriers Corp. v. Empire Programs, Inc., 488 F. Supp. 2d 375, 380 (S.D.N.Y. 2007) (quoting Fasolino Foods Co., Inc. v. Banca Nazionale del Lavoro, 961 F.2d 1052, 1056 (2d Cir. 1992) (internal quotation marks and citation ...

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