Ninth Circuit Finds Bad Faith In Insurer’s Refusal To Defend Mixed Allegations

A panel of the Ninth Circuit held, in an unpublished opinion, that Allied World Specialty Insurance Company (Allied) must defend its insureds even though there were undisputedly excluded allegations of sexual abuse in the underlying complaint. Based upon a substantial body of cases setting forth the “potentiality standard” for determining the duty to defend, the Ninth Circuit held that the Allied policy provided defense coverage because there were allegations that were “conceivably covered.” The Panel partially reversed the district court’s summary judgment ruling in favor of Allied World, finding it breached its duty to defend, and the breach supported the finding that Allied World also breached its common law duty of good faith and violated the Insurance Fair Conduct Act.

The Allied policy at issue provided affirmative coverage for claims of sexual harassment but excluded coverage for “any Loss in connection with any Claim … alleging, arising out of, based upon, attributable to or in any way relating to any actual or alleged sexual molestation or sexual abuse.” (emphasis added). Allied denied coverage arguing that the underlying complaint’s allegations of excluded sexual abuse and covered sexual harassment were “too intertwined” and that any allegation of sexual abuse renders the entire complaint excluded because all allegations “related to” the alleged sexual abuse allegations.

The Ninth Circuit rejected Allied’s interpretation, refusing to interpret the phrase “relating to” in an exclusion broadly, and finding that the allegations of the underlying complaint could be separated into covered and excluded parts in “at least two ways.” The Panel held that a trier of fact could impose liability for only some causes of actions based exclusively on the covered allegations (sexual harassment) and not the excluded conduct (sexual abuse), and that the plain and ordinary meaning of the terms in the exclusion may not even reach some of the alleged conduct. The Panel concluded that because the policy “conceivably covers the Underlying Complaint in part” and because Allied had the “duty to defend any Claim which is covered in whole or in part,” Allied was liable for breach of contract for denying the defense.

While this case demonstrates a recent application of the rule, many jurisdictions beyond the Ninth Circuit enforce the “potentiality” or “conceivably covered” standards for determining the duty to defend. Policyholders should be prepared to push back against blanket denials due to excluded allegations where the underlying complaint also includes potentially covered allegations.

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