Refusing Defense on Pleadings Can Be Expensive

Where the Insured Defaults the Insurer is Bound to Prove the Pleadings are Untrue

Scottsdale insurance Company refused to defend its insureds based on an application of the policy wording to the allegations of the underlying suit. The defendant in the underlying suit, without a defense, allowed a default judgment to be entered. The insured assigned the rights against the insurer who was then ordered by the trial court to pay the policy’s limit plus interest.


In Scottsdale Insurance Company v. Timothy L. Byrne, as Co-Chairman of the Board of Trustees for the Plumbers and Pipefitters Local 51 Pension and Annuity Funds; Robert Bolton, as Co-Chairman of the Board of Trustees for the Plumbers and Pipefitters Local 51 Pension and Annuity Funds, No. 18-1526, United States Court of Appeals For the First Circuit (January 16, 2019) Wellesley Advisory Reality Fund I, LLC (“WARF”) was sued.

Acting in their capacity as representatives of the Board of Trustees for the Plumbers and Pipefitters Local 51 Pension and Annuity Funds (the “Funds”), the suit alleged that WARF had mismanaged and squandered money that the Funds had invested in that entity.

Scottsdale brought an action against Appellees seeking a declaration that it did not owe WARF a duty to defend or indemnify under the policy and so owed the Funds nothing, and the Funds counterclaimed. The United States District Court for the District of Massachusetts ruled that the exclusions in Scottsdale’s policies did not relieve the insurer of its duty to defend WARF in the prior action.

In a subsequent order, the district court awarded the Funds $3 million, the full limits of the insurance policy, plus post-judgment interest.


The dispute in this appeal stems from a “Business and Management Indemnity Policy” (the “Policy”) issued by Scottsdale to WARF, a real estate investment vehicle developed by Wellesley Advisors. The Policy covered the period from November 15, 2013, to December 15, 2014, and carries a coverage limit of $3 million.

The Policy contains a number of exclusions, three of which are claimed to be relevant to the present appeal. First, the Policy includes a “Professional Services Exclusion” which states:

Insurer is not liable for Loss . . . on account of any Claim[] alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving the rendering or failure to render Professional Services. . . .

Solely for purposes of this exclusion, Professional Services means services as a real estate broker or agent, multiple listing agent, real estate appraiser, title agent, title abstractor or searcher, escrow agent, real estate developer, real estate consultant, property manager, real estate inspector, or construction manager. Such services shall include, without limitation, the purchase, sale, rental, leasing or valuation of real property; the arrangement of financing on real property; or any advice proffered by an Insured in connection with any of the foregoing.

Second, the Policy provides an “ERISA Exclusion” which states that Scottsdale

shall not be liable for Loss . . . on account of any Claim . . . for any actual or alleged violation of the responsibilities, obligations or duties imposed by [the] Employee Retirement Income Security Act of 1974, as amended [“ERISA”], or any rules or regulations promulgated thereunder, or similar provisions of any federal, state or local statutory or common law[.]

Finally, the Policy provides a “Conduct Exclusion” which excludes coverage for

Loss . . . on account of any Claim . . . alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving: . . .

the gaining of any profit, remuneration or financial advantage to [which any] Management Insureds were not legally entitled; provided, however this exclusion [] shall not apply unless and until there is a final judgment against such Management Insureds as to such conduct.


The suit averred that WARF “squandered the entire [$5 million] investment,” and that “[t]he properties were either lost to foreclosure or written down to a zero value because of taxes or mortgages owed.”

Based on these allegations, the Funds brought two claims in state court against WARF for negligence and violations of ERISA, respectively. Under the first of these claims WARF was negligent in overleveraging the properties in excess of their value. The second, ERISA-based count claimed WARF took on and breached its fiduciary duties to the Funds.

Scottsdale refused to either defend or indemnify WARF as to the Funds’ claims. WARF went into receivership and did not contest the Underlying Action thereafter. On November 25, 2015, the district court entered default judgment in the Underlying Action of $5,005,422.12.


The insurer’s duty to defend is independent from, and broader than, its duty to indemnify. Insurers owe a duty to defend their insured if the allegations in the underlying lawsuit are reasonably susceptible to an interpretation that they state a claim covered by the policy. For the duty of defense to arise, the underlying complaint need only show, through general allegations, a possibility that the liability claim falls within the insurance coverage.

Where an insurer asserts that it is not obligated to defend due to some policy exclusion or exclusions it bears the initial burden of demonstrating that the exclusion applies.  In order to meet this requirement, the facts alleged in the third-party complaint must establish that the exclusion applies to all potential liability as matter of law. If even one of the counts in either of the complaints falls within the coverage provisions but outside any exclusion, the insurer would have a duty to defend the entire lawsuit.


Scottsdale first contends that all of the allegations in the Underlying Action fall within the purview of the Professional Services Exclusion. In particular, it contends that all of the allegations in that case “arose out of” or “involved” “real estate development, property management, the purchase of real property, or the arrangement of financing on real property,” all of which Scottsdale argues fall “within the plain meaning of the Professional Services Exclusion.”

Scottsdale’s argument fails to account for all of the claims raised in the Underlying Action. The Underlying Action concerned losses stemming from WARF’s investment in three properties. Were those allegations limited to claims regarding the mismanagement of The Stone House, we might agree: claims stemming from WARF’s renovation of that property and retention of revenues from its operation of the hotel as a “management” fee fit seemingly well within the exclusion for actions taken “as a . . . real estate developer [or] . . . property manager.” As the district court observed, “[a]t the very least, it is ambiguous whether in fact all of WARF’s purported misconduct stemmed from” WARF’s provision of professional services. Thus, the allegations concerning the Newport and North Attleboro properties are not clearly within the Professional Services Exclusion, and, where there is ambiguity, there is a duty to defend.


The Underlying Action asserted both a negligence claim and, separately, a claim that WARF’s actions violated duties imposed by ERISA. The parties do not dispute that the latter of these claims falls outside of the Policy’s coverage, and that count is not at issue here.

Scottsdale has the burden of demonstrating the exclusion’s application to the Underlying Action, and all ambiguities must be read against the insurer. Accordingly, there was no basis for excusing Scottsdale from its duty to defend based on the ERISA Exclusion.


Where the insured defendant defaults, the factual allegations in the complaint as to liability are deemed to be admitted and treated as if they are true as to both the defendant and those insurers who wrongfully decline to defend the case.

Subject to these provisos, an insurer that wrongfully declines to defend a claim where some of the claims fall within a policy’s coverage and others do not, an insurer that breaches its duty to defend bears the burden of allocating a judgment against its insured between covered and noncovered claims.


Most fair claims practices regulations require an insurer to do a thorough investigation of a claim before making a decision. Relying on an interpretation of the allegations of a suit as it applies to an insurance policy’s exclusions is fraught with danger. When a default is entered every allegation is treated as if proved. Scottsdale found out its interpretation was wrong and the error cost them more than $3 million. That loss could have been avoided by defending under a reservation and, if the evidence at trial proved no coverage, they could seek return of the cost of defense and any indemnity required to be paid.

© 2019 – Barry Zalma

This article, and all of the blog posts on this site, digest and summarize cases published by courts of the various states and the United States.  The court decisions have been modified from the actual language of the court decisions, were condensed for ease of reading, and convey the opinions of the author regarding each case.

Barry Zalma, Esq., CFE, now limits his practice to service as an insurance consultant  specializing in insurance coverage, insurance claims handling, insurance bad faith and insurance fraud almost equally for insurers and policyholders. He also serves as an arbitrator or mediator for insurance related disputes. He practiced law in California for more than 44 years as an insurance coverage and claims handling lawyer and more than 50 years in the insurance business. He is available at and

Mr. Zalma is the first recipient of the first annual Claims Magazine/ACE Legend Award.

His newest book:



Insurance is a contract between a person seeking insurance and an insurer. It is obtained by making contact with the insurer as a prospective insured seeking insurance. The homeowners policy is a specialized policy of insurance that protects the homeowner from certain risks of loss to the real and personal property at the home, the exposure the insured faces for injury to a household employee, and the exposure the insured faces to liability for bodily injury or property damage caused to third parties. The book explains how to buy a homeowners policy and how to collect on any claim made to the homeowners insurer.

Paperback Book    Kindle Book

Books from Full Court Press

Insurance Law Deskbook: Learn the insurance basics that are essential to every civil practitioner. The Insurance Law Deskbook is intended to help law students, practitioners, insurance lawyers, professional claims personnel, insured persons, and anyone else involved in insurance. The book, published for the first time under Full Court Press, includes the full texts or digests of insurance-related decisions of the U.S. Supreme Court, the U.S. District Courts of Appeal, state appellate courts, and foreign courts that have molded the American insurance law, as well as vital explanatory chapters, historical context, form letters, and more.

California Insurance Law Deskbook: California has long led the way when it comes to insurance jurisprudence in the United States, and few know more about California insurance law than Barry Zalma. The California Insurance Law Deskbook is intended to help law students, practitioners, insurance lawyers, professional claims personnel, insured persons, and anyone else involved in insurance. Similar to Barry Zalma’s general Insurance Law Deskbook, this title focuses on the state where the author has long resided and practiced as an expert in California law. The book, published for the first time under Full Court Press, includes the full texts or digests of insurance-related decisions of the U.S. Supreme Court, the U.S. District Courts of Appeal, and California appellate courts, as well as vital explanatory chapters and historical context.

Insurance Bad Faith and Punitive Damages Deskbook: Understand the relationship between insurance, the tort of bad faith, and why punitive damages are awarded to punish insurers. Previously, a person suing an insurance company in the United States could only recover contract damages, but when the tort of bad faith was created by the courts contract law was enormously affected, allowing insureds to sue insurers for both contract and tort damages, including punitive damages. Read a thoughtful analysis of how punitive damages apply in the United States to insurance bad faith suits, and why some states allow judges and juries to award punitive damages against insurers in civil litigation.



About Barry Zalma

An insurance coverage and claims handling author, consultant and expert witness with more than 48 years of practical and court room experience.
This entry was posted in Zalma on Insurance. Bookmark the permalink.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.