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NEW YORK -- Insurers do not have a duty to defend emotional distress claims under commercial general liability policies when those claims result from economic loss, a federal appeals court says.

The ruling, issued earlier this month, prevents a policyholder from seeking more than $6 million in damages and defense costs from its insurer.

New York's highest court previously has ruled that emotional distress constitutes bodily injury and is covered by CGL policies when the distress is caused by an accident, but there is no coverage when the distress does not result from an accident.

The ruling curbs the creeping extension of CGL coverage in New York, said Marshall T. Potashner, an associate at Wilson, Elser, Moskowitz, Edelman & Dicker L.L.P. in New York who represented Boston-based Liberty Mutual Insurance Co., the insurer in the case.

"It sets out some boundaries," he said.

The 2nd U.S. Circuit Court of Appeals in New York ruled that Liberty Mutual did not have a duty to defend claims made against First Investors Corp. in New York.

First Investors had received multiple claims of emotional distress arising out of investors' economic losses.

The claimants charged in court papers that First Investors fraudulently targeted mostly retired, unsophisticated investors and sold them highly volatile junk bond mutual funds while assuring them the investments were safe and suitable for people living on a fixed income.

Liberty Mutual agreed to provide coverage for two of a dozen suits against First Investors, as it was concerned that its claims examiners had misled First Investors regarding the availability of coverage. Liberty Mutual settled the two suits for $3.45 million.

First Investors then sought indemnification and defense costs for the other suits it faced.

In 1995, First Investors sought summary judgment on the duty to defend. The federal district court denied the motion in 1997. Under New York law, insurers' duty to defend is wider than the duty to indemnify.

First Investors asserted that based on the 1992 decision in Lavanant vs. General Accident Insurance Co. of America by the New York Court of Appeals, the highest court in the state, emotional distress arising out of economic loss constitutes bodily injury and is covered by CGL policies.

In Lavanant, tenants of a property sought damages for emotional distress after a ceiling collapse, even though they did not suffer any physical injury. The court held that in those circumstances, coverage for bodily injury did include emotional distress.

But the First Investors case differed because there was no "occurrence" or "accident" that caused the emotional distress, the 2nd Circuit ruled.

"It was the economic losses resulting from the diminishment in value of the investments that caused the emotional distress. Simply stated, those economic losses do not constitute an 'accident,' " according to appeals court.

CGL policies insure against alleged torts causing bodily injury rather than economic loss, according to the court.

"In sum. . .because, under New York law, CGL policies insuring against 'bodily injury, sickness, and disease' do not cover emotional distress claims arising out of economic losses of the sort alleged in the underlying claims, Liberty Mutual has no duty to defend under those policies," the court concluded.

The ruling sets an important precedent in New York on an issue receiving increasing attention in many states, said Mr. Potashner.

"If it had gone against the insurer, then companies would have been able to argue that other types of claims with emotional distress issues should be covered," he said.

Attorneys for First Investors did not return telephone calls.

First Investors Corp. vs. Liberty Mutual Insurance Co., 2nd U.S. Circuit Court for Appeals; Nos. 97-9407, 97-9435