Scottsdale Insurance Company v. McGrath

Background

Scottsdale Insurance Company issued a directors-and-officers insurance policy to Watershed Ventures, LLC. The policy covered Watershed and certain subsidiaries, as well as their directors and officers. Rocky Aspen, LLC was formed as a joint venture involving Watershed’s subsidiary and AH DB Kitchen Investors LLC. Patrick McGrath was appointed AH DB’s designated co-manager of Rocky Aspen.

After AH DB failed to make required funding contributions, Watershed’s subsidiary obtained additional ownership rights and later removed McGrath as Rocky Aspen’s co-manager. Rocky Aspen then entered bankruptcy proceedings, and claims were asserted against McGrath. Scottsdale denied that McGrath was insured under the policy. In an earlier ruling, the court held that Rocky Aspen qualified as a Watershed subsidiary and that McGrath was an insured during the relevant period. That earlier ruling left open whether the underlying claims were covered and whether McGrath could recover more than the policy limits.

McGrath’s counterclaims included a claim for bad-faith breach of the insurance contract. He alleged that Scottsdale should have recognized his insured status earlier, failed to inform him of its position, denied coverage, and responded too late to a settlement demand from a bankruptcy trustee. He also sought consequential and punitive damages beyond the policy limits.

Bad-faith liability

The court granted summary judgment against McGrath’s independent bad-faith claim. Under New York law, an insurer may face bad-faith liability in some third-party insurance circumstances, but there is a strong presumption against such liability. A refusal to defend must involve more than a reasonable disagreement about coverage and must show a gross disregard of the insurer’s policy obligations.

The court held that Scottsdale had no policy obligation to proactively tell McGrath that it did not consider him insured after responding to Watershed’s notice of claim. The policy instead required an insured to provide notice of a claim as a condition of receiving payment. The court also held that Scottsdale’s 2019 coverage position was not evidence of bad faith. Scottsdale had reasonable arguments for its interpretation of the policy, even though the court ultimately rejected those arguments in the earlier ruling.

The court separately rejected McGrath’s bad-faith failure-to-settle theory. Under New York law, the insurer must have exercised exclusive control over the claim, generally because it assumed the insured’s defense. Scottsdale did not assume McGrath’s defense or control the settlement decision. It reserved its rights, denied coverage, and left McGrath free to settle and later seek reimbursement under the policy. Because Scottsdale did not assume the defense, the court held that McGrath could not pursue a bad-faith refusal-to-settle claim.

Consequential damages

The court also granted Scottsdale summary judgment dismissing McGrath’s request for consequential damages. Such damages can sometimes exceed policy limits when they were within the parties’ reasonable contemplation when they made the contract. The court found that this policy was an agreement to pay covered losses and defense or indemnification costs up to stated limits, not a contract whose central purpose was to preserve a business or property from deterioration. McGrath therefore had not shown that the additional damages he sought were reasonably contemplated when the policy was issued.

Punitive damages

The court granted summary judgment dismissing the request for punitive damages. Under New York law, punitive damages for a contract dispute generally require an independent tort involving particularly egregious conduct directed at the plaintiff and part of a pattern affecting the public. The court held that McGrath had not identified a tort independent of the insurance contract, which was fatal to the punitive-damages request.

Disposition

The court granted Scottsdale’s motion for partial summary judgment. The order dismissed McGrath’s second counterclaim and the prayer for consequential and punitive damages. The opinion did not dismiss McGrath’s underlying breach-of-contract claim for amounts within the policy limits.