In Lee v. West Coast Life Insurance Company, 2012 U.S. App. LEXIS 15768 (9th Cir. July 31, 2012), the Ninth Circuit Court of Appeals ruled that a stakeholder insurance company cannot use an interpleader filing to shield itself from tort liability for its negligent actions.  With this holding, the Court of Appeals confirmed that “where the stakeholder may be independently liable to one or more claimants, [an] interpleader does not shield the stakeholder from tort liability, nor from liability in excess of the stake.”

In 1998, West Coast Life Insurance Company issued a policy on the life of Steve Lee, Sr.  Over the next ten years, West Coast received numerous change of ownership and change of beneficiary forms from members of the Lee family.  However, in 2005, West Coast’s Director of Policy Administration gave erroneous instructions regarding who should sign particular forms, and in what capacity those forms should be signed.  Assuming that West Coast had properly instructed them in completing those forms, the Lee family made several subsequent changes to the policy’s ownership and beneficiaries.  When Mr. Lee died in 2009, West Coast realized that the 2005 changes were not properly executed, and informed certain members of the Lee family that they were not entitled to the life insurance benefits.

With West Coast’s discovery, two groups of the Lee family claimed that they were entitled to the life insurance proceeds:  the named beneficiaries prior to the 2005 changes and the named beneficiaries at death.  That first group of Lee family members (the pre-2005 beneficiaries) filed suit against West Coast for breach of contract and breach of the covenant of good faith and fair dealing.  West Coast filed a counterclaim-in-interpleader, deposited the life insurance proceeds, plus interest, with the Court, and added the other members of the Lee family (the post-2005 beneficiaries) as counterclaimants.  The post-2005 beneficiaries then filed counterclaims for negligence and declaratory relief against West Coast, as well as cross-claims against the pre-2005 beneficiaries.

Eventually, the members of the Lee family settled their disputing claims to the life insurance proceeds, with the pre-2005 beneficiaries receiving $290,000, and the post-2005 beneficiaries collecting the remainder of the funds.  This did not end the litigation however, as the post-2005 beneficiaries maintained that West Coast was liable to them for the insurance proceeds allocated to the pre-2005 beneficiaries, as well as for attorneys’ fees incurred in litigating the cross-claims against them.

Following a bench trial on stipulated facts, the district court issued judgment in West Coast’s favor, ruling that the post-2005 beneficiaries failed to allege any cognizable damages flowing from West Coast’s alleged negligent conduct, and therefore it did not need to address the merits of the post-2005 beneficiaries’ negligence claims.  Specifically, the district court “concluded that attorney’s fees are not recoverable in interpleader actions absent a showing of bad faith.”  In overturning the district court’s ruling, the Ninth Circuit explained that while an interpleader does protect “the stakeholder from being obliged to determine as this peril which claimant has the better claim … interpleader protection generally does not extend to counterclaims that are not claims to the interpleaded funds.”

Here, the post-2005 beneficiaries “alleged that West Coast’s negligent actions in 2005 caused the instant controversy, and claim damages flowing from that negligence.”  Thus, because their “damages flowed not from West Coast’s filing of an interpleader complaint but from its alleged negligent conduct,” the post-2005 beneficiaries were not required to show that West Coast acted in bad faith.  Accordingly, because interpleader protection does not extend to counterclaims that are not claims to the interpleaded funds, West Coast could be liable for its negligent actions.

Based on this ruling, an insurance company cannot use an interpleader filing as a shield to protect itself from liability for its own negligent (or for that matter bad faith) actions.  When the insurance company is not blameless with respect to the underlying controversy, it can face tort liability from a party that claims an interest in the disputed funds.  In fact, an insurance company can face liability for negligence, and can even be liable for certain attorneys’ fees incurred in such an action.