Jacobs v. Liberty Surplus Insurance Corporation

Background

Scott Crocker Jacobs was the trustee for, and a beneficiary of, a trust. He purchased a professional liability insurance policy from Liberty Surplus Insurance Corporation. Another trust beneficiary filed a state-court petition seeking Jacobs’s removal as trustee, an accounting, appointment of a successor trustee, and attorney’s fees. The petition alleged breaches of Jacobs’s fiduciary duties and sought to hold him personally liable for certain costs and fees.

Jacobs alleged that he timely submitted the petition to Liberty, but Liberty did not defend him. Jacobs paid for his own defense, and the state-court litigation settled in January 2020. He alleged that $400,000 was paid to the beneficiary, attorneys, and attorneys representing another beneficiary, and that his fees and costs exceeded $300,000. Liberty denied coverage in May 2020. Jacobs then sued, alleging breach of contract, violation of the implied covenant of good faith and fair dealing, negligence, and violation of California’s Unfair Competition Law.

Liberty moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), arguing that the policy did not require it to defend Jacobs or pay the settlement, attorney’s fees, and costs.

Breach of contract

The court rejected Liberty’s argument that the state-court petition was not a “claim” under the policy because the trust, rather than Jacobs, appeared in the caption. The policy defined a claim to include a civil action or proceeding naming the insured and seeking monetary or non-monetary relief arising from a wrongful act.

The court held that the petition qualified as a claim. It sought to impose liability on Jacobs in his individual capacity and personally, and it sought relief against him as trustee. Applying California rules that insurance coverage is interpreted broadly and from the perspective of a reasonable insured, the court concluded that a reasonable insured would understand the policy to cover this situation. The court also relied on California law recognizing that a trust is not itself a legal entity that can sue or be sued and that legal proceedings involving a trust are generally directed at the trustee.

The court also rejected Liberty’s argument that Jacobs could not recover because Liberty had not consented to his counsel, settlement, fees, or costs. Under the court’s reading of California law, an insurer that wrongfully denies coverage or refuses to defend cannot later rely on its lack of consent to avoid responsibility for a reasonable, good-faith settlement. The same principle may require reimbursement of reasonable attorney’s fees when the insurer wrongfully refuses to defend.

The court further held that the petition’s requests for non-monetary remedies did not eliminate the potential duty to defend. The policy expressly covered claims seeking non-monetary relief, and California law requires an insurer to defend the entire action when a third-party lawsuit includes at least one claim that is potentially covered, even if other claims may fall outside the policy.

Policy exclusions and endorsements

Liberty relied on exclusions concerning commingling, misappropriation, or improper use of funds or property; services as an investment manager, financial adviser, financial custodian, accountant, or lawyer; and conduct involving discretionary authority beyond the trustee’s authority under the trust documents.

The court did not decide whether those exclusions ultimately precluded coverage. It said the parties had not adequately developed or briefed the exclusions. The court observed that the third exclusion appeared not to apply based on the petition, but it found that the other exclusion arguments required further analysis and possibly a more developed record. The court specifically stated that it was not finding the exclusions unclear or ambiguous; it simply could not determine their applicability at the motion-to-dismiss stage.

Good faith and fair dealing

Liberty argued that Jacobs could not state a claim for violating the implied covenant of good faith and fair dealing because there was no coverage, or because a genuine dispute existed over coverage. The court explained that California generally does not allow a bad-faith claim when a genuine coverage dispute shows that the insurer did not act in bad faith.

The court concluded, however, that this general rule does not automatically defeat a bad-faith claim concerning an insurer’s duty to defend a third-party lawsuit. Because an insurer must defend when there is a potential for coverage, the court reasoned that an insurer facing a genuine coverage dispute may still be required to defend first and seek reimbursement or other relief later. A jury could therefore find bad faith based on the circumstances if an insurer chooses not to defend while disputing the scope of coverage.

Disposition

The court denied Liberty’s motion to dismiss. The order did not finally determine whether the policy exclusions barred coverage or whether Jacobs would ultimately recover the settlement, fees, or costs.