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K2 Investment Group, LLC, et al v. American Guarantee & Liability Insurance Company

January 3, 2012


K2 Inv. Group, LLC v American Guar. & Liab. Ins. Co.

Published by New York State Law Reporting Bureau pursuant to Judiciary Law § 431.

This opinion is uncorrected and subject to revision before publication in the Official Reports.

Decided on January 3, 2012

Gonzalez, P.J., Tom, Andrias, Acosta, Abdus-Salaam, JJ.

Judgment, Supreme Court, New York County (Ira Gammerman, J.H.O.), entered June 23, 2010, in plaintiffs' favor against defendant on the causes of action to enforce a default judgment and dismissing the causes of action alleging bad faith, affirmed, with costs. Appeal from order, same court and J.H.O., entered on or about June 14, 2010, unanimously dismissed, without costs, as subsumed in the appeal from the judgment.

Plaintiffs are limited liability companies that made multiple loans totaling approximately $3 million to nonparty Goldan, LLC of which defendant's insured, Jeffrey Daniels, an attorney, was a member. In the legal malpractice action underlying this action, it was alleged that as attorney for plaintiffs, Daniels undertook to record mortgages in plaintiffs' favor to secure those loans, and to obtain title insurance, and that he failed to do so, rendering plaintiffs' investments unsecured. Goldan became insolvent and never made any payments on the loans. The legal malpractice action alleged that as a consequence of Daniels's negligent failure to record the mortgages or obtain title insurance, plaintiffs did not have security in the mortgaged properties, and the promissory notes evidencing the loans became uncollectible.

Plaintiffs demanded $450,000 from Daniels in full settlement of their claims. This amount was well within the $2 million aggregate and $2 million per-claim limits of the lawyers professional liability insurance policy issued to Daniels by defendant. However, defendant disclaimed its duty to defend or indemnify based upon two exclusions in the policy. One exclusion was for claims based upon or arising out of the insured's capacity or status as an officer, director, etc., of a business enterprise. The other exclusion was for any claim arising out of the alleged acts or omissions of the insured for any business enterprise in which he had a controlling interest.

After Daniels failed to appear in the malpractice action, a default judgment was entered against him in the amounts of $2,404,378.36 in favor of plaintiff K2 and $688,716.00 in favor of plaintiff ATAS. Daniels then assigned to plaintiffs all his claims against defendant, including bad faith claims.

Having disclaimed its duty to defend its insured in an action that culminated in a default judgment, defendant "cannot challenge the liability or damages determination underlying the judgment" (Lang v Hanover Ins. Co., 3 NY3d 350, 356 [2004]). Nor can it raise defenses to plaintiffs' claim against Daniels (Rucaj v Progressive Ins. Co., 19 AD3d 270, 273 [2005]). However, defendant is entitled, in the direct action against it, to raise defenses with respect to its obligations to cover the claims against Daniels, including the applicability of any asserted policy exclusions (Lang at 356).

"While the duty to defend is generally measured against the allegations of the pleadings in the underlying action, the duty to indemnify is distinctly different, for it is determined by the actual basis of the insured's liability to plaintiff" (Robbins v Michigan Millers Mut. Ins. Co., 236 AD2d 769, 770 [1997]). Contrary to defendant's argument here, the exclusions did not apply with respect to either the duty to defend which was demonstrated based upon the allegations of legal malpractice or the duty to indemnify for a judgment based in legal malpractice. Thus, defendant cannot at this juncture assert defenses that would have defeated the legal malpractice claims (for example, that Daniels was not performing legal services for plaintiffs but was instead representing Goldan) or would have established the applicability of the exclusions, to the extent that the applicability of the exclusions is inconsistent with the judgment determining Daniels's liability to plaintiffs for legal malpractice (see Lang, 3 NY3d at 356; compare Fisher v Hanover Ins. Co., 288 AD2d 806 [2001], and Fusco v American Colonial Ins. Co., 221 AD2d 231 [1995] [where default judgment was entered against insured, insurer's disclaimer based on policy's notice requirements was valid defense to action pursuant to Insurance Law § 3420(b)(1)]).

"To be relieved of its duty to defend on the basis of a policy exclusion, the insurer bears the burden of demonstrating that the allegations of the complaint in the underlying claim cast the pleadings wholly within that exclusion, that the exclusion is not subject to any other reasonable interpretation, and that there is no possible factual or legal basis upon which the insurer might be eventually obligated to indemnify its insured (citations omitted)" (Utica First Ins. Co. v Star-Brite Painting & Paperhanging, 36 AD3d 794, 796 [2007]). No material issue of fact exists as to whether the allegations of plaintiffs' legal malpractice claims are based, even in part, upon Daniel's acts or omissions in his capacity as an officer, director, etc., of a business enterprise or any acts or omissions for a business enterprise in which he had a controlling interest, so as to bring them within either of the exclusions invoked by defendant (id). Rather, the allegations of legal malpractice were focused solely on Daniels's negligence as plaintiffs' counsel.

Although plaintiffs allege that Daniels was a member of Goldan, the basis of the legal malpractice action was that Daniels agreed to act as plaintiffs' attorney in the preparation of mortgages and related notes, in arranging for title insurance at Goldan's expense, and in recording the mortgage liens, that he failed to record the mortgages and obtain title insurance, and that his failure was a departure from good and accepted legal practice, and caused injury to plaintiffs. It was not alleged that Daniels was negligent in rendering legal services to his business enterprise, Goldan. The action was based exclusively on his obligation to plaintiffs, not to Goldan. With respect to defendant's duty to indemnify, Daniels's alleged controlling interest in Goldan did not affect his obligations to plaintiffs as their lawyer. His liability to plaintiffs is premised solely on the attorney-client relationship between him and plaintiffs, not on any interest that he had in Goldan.

Thus, the exclusions relied upon by defendant are patently inapplicable. That Daniels was an owner of Goldan or might have been acting in the interests of Goldan instead of those of his clients may explain why Daniels acted as he did, but it does not change the essence of the complaint, or the basis of liability, which is that Daniels committed legal malpractice in his representation of plaintiffs (see American Guar. & Liab. Ins. Co v Moskowitz, 58 AD3d 426 [2009] [rejecting similar arguments advanced by defendant]). Daniels committed legal malpractice while he was an owner, officer, etc., of Goldan. However, the policy does not exclude coverage for all conduct occurring while he was an owner or officer but only for claims arising out of his capacity as such (see RJC Realty Holding Corp. v Republic Franklin Ins. Co., 2 NY3d 158, 165 [2004]).

The dissent concludes that there is an issue of fact as to the actual basis of Daniels's liability to plaintiff, and thus as to the applicability of the exclusions, pointing to issues that can be raised by defendant outside the allegations of the complaint and the default judgment of legal malpractice, such as whether Daniels also represented Goldan. This interpretation of the policy exclusions is overly broad, as the exclusions are more reasonably understood to be "designed to exclude claims based upon legal work performed by an insured for an enterprise in which he or she has some kind of ownership interest and thus where the insured is likely to benefit directly from recovery under the policy" (Oot v Home Ins. Co. of Ind., 244 AD2d 62, 70 [1998]; see also Niagara Fire Ins. Co. v Pepicelli, Pepicelli, Watts and Youngs, P.C., 821 F2d 216, 220 [3d Cir 1987] ["The exclusions speak of excluded claims, and thus the character of the specific legal claims, rather than the malpractice suit's general factual background, must be analyzed to determine the exclusion issue. The claims made by (the legal malpractice claimant) deal only with negligence and breach of contract in the Law Firm's representation of the (legal malpractice claimant), and resolution of the claims will affect only the interests of (the legal malpractice claimant) and the Law Firm . . . Therefore, the legal malpractice claims are not omitted from coverage by the two exclusions . . . ...

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