Four plaintiffs, who had settled a state court lawsuit against a behavioral health system, sued their insurer, Allied World Specialty Insurance Company, for breach of contract and bad faith. The insurer had declined to defend the health system against allegations of sexual harassment and abuse, relying on a 'Sexual Abuse Exclusion' in the policy. The district court granted summary judgment to the insurer, ruling that the exclusion barred coverage for the entire complaint. The plaintiffs appealed, arguing that the policy covered sexual harassment and that the exclusion should not bar coverage for allegations that did not involve physical contact or force.
The Ninth Circuit applied Washington law, which mandates that the duty to defend arises whenever the policy could conceivably cover the allegations in a complaint. The court found the 'Sexual Abuse Exclusion' ambiguous because the terms 'sexual molestation' and 'sexual abuse' were not defined in the policy. Under Washington law, such terms must be given their plain, ordinary meaning, which typically requires physical contact and force. The plaintiffs' allegations included verbal harassment, excessive strip searches without touching, and unwanted hugging, which did not meet the ordinary definition of sexual abuse or molestation. Consequently, the court held that the complaint could be separated into covered and excluded portions. Because the policy imposed a duty to defend claims covered 'in whole or in part,' the insurer was liable for denying the defense. The court further found that the insurer acted in bad faith by putting its own interests ahead of the insured and resolving ambiguities in its own favor. Additionally, the insurer violated the Washington Insurance Fair Conduct Act by unreasonably denying the claim. However, the court vacated the ruling on the Consumer Protection Act claim, noting that the plaintiffs had not sufficiently argued the specific elements required for that statute.
The case is remanded to the district court with instructions to grant partial summary judgment in favor of the plaintiffs on the breach of contract, bad faith, and Insurance Fair Conduct Act claims. The district court must determine the appropriate damages, including the full amount of the underlying settlement via the remedy of coverage by estoppel. The insurer is allocated the costs of the appeal. The decision clarifies that insurers cannot deny a defense based on a broad reading of exclusions when the allegations could conceivably fall within the policy's coverage.
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