In Smith, the insured, a financial planner and registered representative, was sued in connection with the alleged sale of unregistered securities to his clients. He tendered the defense of the lawsuit to his professional liability insurer, but the insurer denied coverage based, in part, on a policy exclusion that precluded coverage for claims involving products not approved by the broker/dealer that employed the insured. The insured settled the lawsuit with his former clients and assigned his claims against his insurer to them. The former clients then sued the insurer for breach of contract and statutory bad faith denial of insurance coverage. Following summary judgment in the insurer’s favor, the former clients appealed.
The Third Circuit affirmed the trial court’s grant of summary judgment in the insurer’s favor. The court reasoned that the policy exclusion clearly precluded coverage for the underlying lawsuit. Thus, summary judgment in the insurer’s favor on the breach of contract claim was appropriate. With regard to the statutory bad faith claim, the court explained that Pennsylvania courts have devised a two-part test for determining bad faith under the statute: (1) the insurer must lack a reasonable basis for denying benefits, and (2) the insurer must know, or recklessly disregard, its lack of a reasonable basis. The court concluded that the former clients failed to satisfy the first element, as the insurer “clearly did have a reasonable basis for the denial of coverage.” The court also opined that perhaps the insurer should have communicated with the insured before denying coverage, but noted that “a failure to follow best practices does not give rise to a bad faith claim.”
