Bad-Faith Denials and Your Rights Under Professional Liability Insurance (Errors & Omissions)

Professional liability insurance (Errors & Omissions, or E&O) exists to protect licensed professionals and businesses from claims alleging negligent acts, errors, or omissions in the performance of professional services. When an insurer unreasonably refuses to investigate, defend, or pay on a covered claim, that refusal can constitute a bad-faith denial — a serious legal exposure for the insurer and a critical rights issue for policyholders.

This article, aimed at U.S. professionals (with examples focused on California, New York, and Texas), explains what bad-faith denials look like under E&O policies, the remedies available, practical steps to protect coverage, and how to work with counsel and claims professionals to respond.

What is a bad-faith denial under an E&O policy?

A bad-faith denial occurs when an insurer:

• Unreasonably refuses to investigate a timely and covered claim,
• Unjustifiably denies coverage or refuses to defend a lawsuit that falls within policy terms,
• Delays payment of a covered settlement or judgment without reasonable cause, or
• Misrepresents policy terms or the scope of coverage.

In E&O contexts, common bad-faith facts include denying defense despite allegations that fall within the policy’s insuring agreement, or issuing a reservation-of-rights letter that improperly limits the insured’s ability to control defense or settlement.

Why this matters for professionals in California, New York, and Texas

Bad-faith doctrine and remedies vary by state. Key differences:

• California: Recognizes significant extracontractual remedies for insurer bad faith (including emotional distress and punitive damages in some cases). The California Department of Insurance provides consumer guidance on claims handling and unfair practices. (See: California DOI claims pages.)
• New York: Courts allow tort remedies for unreasonable denials; the NY Department of Financial Services enforces unfair claim practices.
• Texas: Texas law provides statutory and common-law bad-faith remedies; the Texas Department of Insurance offers guidance and complaint processes.

State consumer/insurance regulator pages are practical resources if you suspect bad faith:

• California Department of Insurance — claims help: https://www.insurance.ca.gov/01-consumers/101-help/claims/
• Texas Department of Insurance — claim help: https://www.tdi.texas.gov/consumer/claimhelp.html
• New York State DFS — consumer insurance complaints: https://www.dfs.ny.gov/consumers/insurance/complaints

Common E&O bad-faith scenarios (real-world examples)

• An accounting firm in San Francisco reports a claim for alleged negligent tax advice. The complaint alleges covered professional services and damages. The insurer refuses defense, arguing an unrelated prior-act exclusion without factual support.
• A New York-based tech consultant timely reports a client claim and cooperates fully, yet the insurer delays investigation for months, then denies based on a document the insured never had. Litigation costs and reputational harm ensue.
• A Houston architect’s insurer refuses to settle within policy limits even though a reasonable settlement is available, then gets a verdict exceeding limits. The insured sues the insurer for failing to accept a reasonable settlement (a classic bad-faith trap).

Your rights and remedies if you suspect bad faith

Policyholders can pursue multiple remedies depending on state law and the facts:

• Demand coverage and defense: Insureds can formally demand defense under the policy. If refused, preserve all communications.
• Breach of contract claim: For failure to defend or indemnify under policy terms.
• Bad-faith tort or statutory claim: Many states permit tort remedies for unreasonable claim conduct, including compensatory and sometimes punitive damages and attorney fees.
• Declaratory relief: Ask a court to declare coverage obligations.
• Unfair claims practice complaint: File with the state insurance regulator.

Key practical rights:

• Right to a competent defense: If insurer denies defense, you may hire counsel and seek reimbursement (but check policy consent/consent-to-settle clauses).
• Right to documentation: You can request copies of claim files, reservation letters, and internal emails — essential if bad-faith litigation arises.
• Right to mitigate: You must continue to mitigate damages; preserve documents and notify the insurer promptly.

Immediate steps to protect coverage and preserve claims

Take these actions the moment you suspect a coverage denial may be wrongful:

1. Document everything:
   • Dates and content of all calls/emails with the insurer.
   • The insurer’s reservation-of-rights, denial letters, and any internal demands.
2. Preserve evidence:
   • Save client files, emails, contracts, drafts, engagement letters, and project timelines. See our guide on Document Preservation and Evidence: Protecting Coverage Under Professional Liability Insurance (Errors & Omissions).
3. Provide timely notice:
   • Many policies bar coverage for late notice. If you haven’t already, provide formal written notice and follow the policy’s claim-reporting procedure. See Step-by-Step: Reporting a Claim Under Your Professional Liability Insurance (Errors & Omissions) Policy.
4. Engage counsel experienced in E&O/bad-faith:
   • Early involvement of counsel can protect your rights during reservation letters and coverage disputes.
5. Consider independent appraisal/coverage opinion:
   • A coverage opinion from specialty coverage counsel or a broker can help clarify exposure and strategy.

How insurers commonly defend a denial — and how to respond

Common insurer defenses:

• Policy exclusions (prior acts, known-harm, fraud)
• Late notice
• Lack of allegations triggering “professional services” coverage
• Material misrepresentation on the application

How to respond:

• Produce contemporaneous engagement letters, scope documents, and communications that show the alleged act falls within covered services.
• Challenge tenuous exclusions with factual record.
• Request a coverage position statement and demand the insurer state legal basis for denial.
• If a reservation-of-rights is issued, insist on clear statements about consent-to-settle and right to independent counsel. See: How Defense Counsel Are Selected and Managed in Professional Liability Insurance (Errors & Omissions) Cases.

Costs, common premium ranges, and insurer examples

E&O premiums vary by industry, revenue, limits, claims history, and state. Representative examples for small to mid-size professional exposures (approximate ranges based on insurer market pages):

Notes:

• These ranges are illustrative. Actual quotes depend on revenue, claims history, industry, limits/deductibles, and state regulatory factors.
• In high-liability fields (lawyers, large technology consultants, architects), premiums and retentions rise substantially — often into five-figure annual costs for robust limits.

Litigation strategy and insurer selection: what policyholders should expect

• Early involvement of experienced coverage counsel is essential. A coverage lawyer can file declaratory relief, negotiate tolling agreements, and preserve statutes of limitation.
• Document preservation is non-negotiable. See our checklist in Document Preservation and Evidence: Protecting Coverage Under Professional Liability Insurance (Errors & Omissions).
• Defense counsel management: If the insurer defends under reservation, insist on transparency about defense strategy and conflicts. For more details, see How Defense Counsel Are Selected and Managed in Professional Liability Insurance (Errors & Omissions) Cases.
• Settlement vs trial: If an insurer refuses a reasonable settlement within policy limits, and a larger judgment follows, you may have a viable bad-faith claim. See related strategy discussion in Settlement vs Trial: Decision Criteria for Professional Liability Insurance (Errors & Omissions) Claims.

When to escalate to regulatory or litigation remedies

Escalate if:

• Denials are conclusory and unsupported by factual investigation.
• The insurer refuses to articulate legal basis for denial.
• The insurer refuses to reimburse reasonable defense costs where the complaint arguably triggers coverage.
• Internal policy language is being misapplied to avoid exposure.

File complaints with the state DOI while preserving litigation rights — regulators can be influential, but they do not replace court remedies.

Conclusion — proactive steps to minimize bad-faith risk

• Review your E&O policy annually for coverage scope, consent and settlement clauses, and notice requirements.
• Maintain meticulous engagement documentation and a claims-response plan.
• If a claim arises and the insurer’s conduct seems unreasonable, document, preserve, notify, and consult experienced coverage counsel immediately.
• Know your state’s enforcement and remedy framework (California, New York, Texas, etc.) and use regulatory avenues when appropriate.

External resources cited:

• Hiscox – Professional Liability Insurance: https://www.hiscox.com/small-business-insurance/professional-liability-insurance
• The Hartford – Professional Liability Insurance: https://www.thehartford.com/professional-liability-insurance
• Travelers – Professional Liability Insurance: https://www.travelers.com/business-insurance/professional-liability

Internal resources you may find helpful:

• Step-by-Step: Reporting a Claim Under Your Professional Liability Insurance (Errors & Omissions) Policy
• Document Preservation and Evidence: Protecting Coverage Under Professional Liability Insurance (Errors & Omissions)
• How Defense Counsel Are Selected and Managed in Professional Liability Insurance (Errors & Omissions) Cases