Lexington Ins. Co. v. MGA Entm’t, No. 12-cv-3677 (SAS), 2014 WL 3955205 (S.D.N.Y. Aug. 12, 2014).

The Southern District of New York denies an insurer’s motion to dismiss an insured’s claim that the insurer breached its duty of good faith and fair dealing by withholding all payment of defense costs where the insurer’s obligation was divisible into undisputed and disputed portions.

On July 10, 2013, the Southern District of New York ruled that National Union Fire Insurance Company of Pittsburgh, Pennsylvania (“National Union”) had a contractual duty to defend MGA Entertainment, Inc. (“MGA”) in connection with a copyright infringement brought by Bernard Belair against MGA (the “Belair action”).  The ruling entitled MGA to recover attorneys’ fees incurred in connection with its defense in the Belair action.  Because MGA had settled with its attorneys for an amount less than originally billed, National Union’s exact obligation to MGA remained in dispute.  On June 10, 2014, the court found that National Union was obligated to pay MGA a total of $2.4 million, plus pre-judgment interest.

Before the court ruled on National Union’s exact obligation, it permitted MGA to file an amended answer.  In its amended answer, MGA included a new counterclaim, alleging that National Union breached its duty of good faith and fair dealing by unreasonably delaying its recovery following the court’s July 10, 2013 ruling on entitlement to a defense.  MGA argued that while National Union’s exact obligation was in dispute, it was unreasonable for National Union to withhold payment of undisputed amounts, including the amounts that it had actually paid to its attorneys in the Belair action.  National Union filed a motion to dismiss, arguing that MGA had failed to state a claim upon which relief could be granted.  National Union argued that because a question remained as to whether it was liable to MGA for the total amounts billed, or only for the amounts MGA actually paid, it was reasonable for it to withhold all payment to MGA.

Because this case was a diversity action, California law applied to the parties’ insurance policy.  The court began its analysis by noting that under California law, all insurance policies contain an implied duty of good faith and fair dealing that is violated when an insurer unreasonably withholds payment of a claim.  The court reasoned that in order for National Union to prevail on its motion to dismiss, it had to establish that, as a matter of law: 1) California law does not recognize a distinction between undisputed and disputed insurance obligations; or 2) MGA had not adduced “plausible” evidence of an undisputed obligation by National Union.  Because it concluded that National Union’s arguments as to both issues failed, the court denied the motion to dismiss.

First, the court reasoned that under established California law, it is unlawful for an insurer to continue to withhold all payment once some portion of an insured’s entitlement is undisputed.  Insurers can therefore be liable for bad faith by refusing to pay the undisputed portion of an obligation, even where the full value of the insured’s entitlement remains unclear.

Next, National Union argued that MGA had not produced sufficient evidence of the undisputed portion of the obligation.  National Union noted that it had repeatedly requested documentation from MGA proving its payment to its attorneys, but that MGA had only supplied internal company spreadsheets.  The court rejected National Union’s argument, reasoning that for the purposes of a motion to dismiss, it had to accept all of MGA’s factual allegations as true.  MGA’s allegations, viewed in the aggregate and taken as true, made it “plausible” to infer that National Union acted in bad faith.  Accordingly, National Union’s motion to dismiss was denied.

The court emphasized that under California law, an insurer is not permitted to withhold payment from an insured if it is clear that payment was due.  The question of whether the undisputed amount owed to MGA by National Union was “clear” at the time National Union withheld payment is a factual issue that is preserved for trial.