George Muhlstock & Co. v. American Home Assur. Co.

• Citation: 117 A.D.2d 117,502 N.Y.S.2d 174
• Parties: GEORGE MUHLSTOCK & CO., Plaintiff-Respondent, v. AMERICAN HOME ASSURANCE COMPANY, Defendant-Appellant.
• Decision Date: 15 May 1986
• Court: New York Supreme Court Appellate Division

Page 174

502 N.Y.S.2d 174

117 A.D.2d 117

GEORGE MUHLSTOCK & CO., Plaintiff-Respondent, v. AMERICAN HOME ASSURANCE COMPANY, Defendant-Appellant.

Supreme Court, Appellate Division First Department.

May 15, 1986.

Norman B. Arnoff, of counsel (Linda K. Bernstein with him on brief; Arnoff & Merin, P.C., New York City), for defendant-appellant.

Carolyn L. Ziegler, of counsel (Flemming, Zulack & Williamson, New York City), for plaintiff-respondent.

Before KUPFERMAN, J.P., and SULLIVAN, CARRO, ASCH and FEIN, JJ.

FEIN, Justice.

Plaintiff, a firm of accountants, was insured by defendant under an accountants liability policy. When plaintiff was made a defendant in a class action suit in federal court, it called upon defendant to defend in that action. Defendant declined to do so. Plaintiff defended and then settled the class action. It brought this action against the insurer to recover the amounts paid in settlement of the class action, plus attorneys fees for the defense of that action.

Under the policy, the insurer agreed in pertinent part as follows:

Accountants' Professional Liability: To pay on behalf of the insured, all sums which the insured shall become legally obligated to pay for damages, other than damages for bodily injury to, or sickness, disease or death of any persons or for injury to or destruction of any tangible property, as the result of any claim or claims caused or alleged to have been caused by the insured, any accountant or accounting organization acting under contract with the insured or any partner or employee of any of the foregoing, in the performance of professional services for others in the insured's professional capacity as an accountant, including but not limited to breach of contract not committed by the insured with affirmative intent:

(a) through neglect, error or omission;

(b) through dishonesty, misrepresentation or fraud, except if made or committed by or at the direction of the insured, any officer or partner of the insured with affirmative dishonesty or actual intent to deceive or defraud;

(c) through civil libel or slander or defamation of character, except if committed in bad faith by an insured, or by any partner, officer or employee of the insured, and except loss and expense due to criminal libel or criminal slander by the insured, or by any partner, officer or employee of the insured.

The terms "professional service" and "insured" were defined as follows:

The unqualified word "insured" includes the named insured, any predecessor in business, and also any officer or partner thereof whether named or not, while acting within the scope of his duties as such and the heirs, executors, administrators and assigns of each insured, in their capacity as such. The insurance afforded to any partner applies also to such partner after his retirement from the insured firm but only as respects professional services performed prior to the effective date of retirement. Any change among the partners of the named insured, even though it results in a change in the name or business style of the named insured, shall not affect the validity of this insurance, but such change shall be reported to the company promptly and in no event later than the next anniversary date of the policy.

"Professional Service" as used in Insuring Agreement I means professional services performed by and advices given by the insured in the conduct of his practice, including, without limitation, duties performed or advices given in relation to matters of taxation.

In October 1976 a client of plaintiff sought its advice as to the advisability of purchasing an interest in a mining tax shelter known as S-J Minerals. One of plaintiff's partners reviewed the material and concluded that such investment was advantageous to the client. The partner also sought out the promoter to ascertain whether plaintiff's principal could purchase such an interest. He was informed that not only could plaintiff's client make such a purchase, but that the promoter would pay plaintiff a 15% commission on the cash portion of purchases by additional clients of plaintiff. As a consequence of plaintiff's recommendations, approximately fifty additional individuals and entities invested in S-J Minerals and related tax shelters. Commission checks from the promoter totalling $180,525 were paid to plaintiff accounting firm. These proceeds were channeled from plaintiff accounting firm to a New Jersey partnership, Golf Court Associates, formed by plaintiff's principals in connection with their purchase of a unit of S-J Minerals.

In late 1978 the SEC commenced an action against various parties in connection with these offerings, including plaintiff accounting firm, which ultimately entered into a consent decree in that case. Defendant insurer was never asked to defend the SEC action. Two weeks later a class action was brought in the United States District Court for the Southern District of New York in which plaintiff and forty-six other parties were sued. In connection with plaintiff's request that defendant insurer defend and indemnify it in this federal class action, plaintiff submitted to defendant the second amended complaint in that action. That complaint was amended twice more. Its final version was the fourth amended complaint. The allegations against plaintiff in that complaint were made in paragraph 62 thereof, which reads as follows:

George Muhlstock & Co. ("Muhlstock"), of 21 East 40 Street, New York, New York, is a certified public accountant firm which offered and sold limited partnership interests in S-J, S-J II and S-J III to members of the class, for which it received $185,000 in undisclosed sales commissions, even though it knew among other things, that the Offering Memoranda stated that no sales commissions would be paid.

The class action complaint also alleged misrepresentations and omissions in the offering memoranda, a conspiracy to defraud, and violations of fiduciary obligations owed to the class by others, which sellers, such as plaintiff, aided and abetted, all in violation of the federal Securities Act of 1933, the federal Securities and Exchange Act of 1934, and § 352-c of the New York General Business Law (the "Martin Act"). The provisions of paragraph 62 were incorporated in each cause of action pleaded against plaintiff.

Defendant insurer examined one of plaintiff's officers after service of the second amended complaint in the federal class action. On that basis, and upon an examination of the complaint in that action, defendant insurer disclaimed coverage. Coverage was denied because plaintiff was being sued not for damages caused by plaintiff's performance of professional services for others in its capacity as an accountant, but rather by reason of its action as a seller of securities or a broker along with many other similarly situated non-accounting firm defendants.

Plaintiff accounting firm defended itself in the federal class action. In March 1983 plaintiff submitted the fourth amended complaint to defendant and again requested defendant to undertake its defense. Defendant declined to alter its disclaimer. Plaintiff then settled the federal class action against it, making no admissions but agreeing to pay the $180,525 it had received as commissions in the sale of S-J Minerals to the members of the complainant class in that action. Plaintiff's attorney in the federal class action submitted a $75,000 bill for services in connection with the defense of that action.

In this action plaintiff seeks damages in the amount of $255,525, representing its claim for legal expenses and the settlement paid in the federal class action.

After answer, defendant moved to dismiss the complaint in the action pursuant to CPLR 3211(a)(7) for failure to state a cause of action, and for summary judgment dismissal under CPLR 3212. The defense was that the allegations in the federal class action fell entirely outside the liability policy. It was noted that plaintiff, as a defendant in the class action, was charged with receiving commissions in a fraudulent sale of tax shelter securities without disclosing the receipt of those commissions. Plaintiff cross-moved for summary judgment asserting that its role in connection with the sale of the tax shelters was advice and that all clients who did purchase had been advised that plaintiff would receive a sales commission. It was also asserted that defendant had indemnified another accounting firm, which was also a defendant in the federal class action. In reply, defendant insurer asserted it had settled with that accounting firm on an understanding that such settlement would have no estoppel effect with respect to the interpretation of the policy.

Special Term found defendant liable for plaintiff's reasonable expense in defending the federal class action, and left for determination at trial the amount of such expense and whether there was an obligation to indemnify. The court found that the broad range of the policy covering "service performed and advice given by the insured in the conduct of his practice" clearly covered plaintiff when it recommended the tax shelters and that the presence of a sales commission, disclosed or not, ethical or not, did not change the nature of the transaction. It further found that the federal class action complaint did not allege facts with sufficient definiteness to clearly bring it within the exclusionary "affirmative dishonesty or actual intent to deceive or defraud" language. Thus, the insurer was obligated to defend.

We disagree. In our view the allegations of the federal class action complaint assert claims entirely outside the scope of the insurance policy. It has long been settled that in determining whether an insurer has a duty to defend, the issue turns upon whether the allegations of the complaint in the underlying action are within the scope of the risk covered by the policy (International Paper Co. v. Continental Casualty Co., 35...