Second Circuit Narrows “Misappropriation” Exclusion: Client‑Authorized Fund Transfers Do Not Defeat Duty to Defend Under New York Law

Introduction

In Marcus & Cinelli, LLP v. Aspen American Insurance Company (No. 24‑2792, decided Oct. 23, 2025), the U.S. Court of Appeals for the Second Circuit reversed the Western District of New York and held that Aspen must defend its insured law firm, Marcus & Cinelli, LLP (“M&C”), against claims brought by a judgment creditor of the firm’s client. Applying New York law, the Court concluded that the underlying state‑court allegations arise from “professional services” and that the policy’s undefined “misappropriation” exclusion does not bar a defense where the complaint does not allege that the firm used client funds without the client’s authorization. Any broader reading of “misappropriation,” the Court held, would present an ambiguity that must be construed in favor of the insured.

The decision presents two core issues significant to professional liability coverage in New York:

What counts as “professional services” in an attorneys’ errors and omissions (E&O) policy.
How to construe a “misappropriation” exclusion when the term is undefined and the complaint alleges client‑authorized fund disbursements that may nonetheless be unlawful as to third parties.

Judge Robinson wrote for the Court (joined by Judge Pérez); Judge Parker dissented.

Summary of the Opinion

The underlying lawsuit (the “Patterson action”) was filed by Patterson Belknap Webb & Tyler LLP (“Patterson”), a judgment creditor of M&C’s client Barbara Stewart. Patterson alleged M&C facilitated the private sale of Stewart’s 24.79‑carat diamond ring and distributed proceeds to itself and others despite Patterson’s prior judgment and a restraining notice under N.Y. C.P.L.R. § 5222(b). Patterson asserted fraudulent conveyance, tortious interference with judgment collection, and civil contempt.

M&C sought a defense from Aspen under its professional liability policy. Aspen denied, contending (i) the allegations did not arise from “professional services” and (ii) a “misappropriation” exclusion applied to funds in the firm’s care, custody or control. The district court agreed with Aspen (on the exclusion) and denied M&C’s motion for partial summary judgment on the duty to defend.

The Second Circuit vacated and reversed:

Professional services: The Court held the face of the complaint alleged conduct involving legal skill and fiduciary handling (e.g., advising on title, negotiating and signing a sale agreement, routing proceeds through an IOLA account, escrow management). That suffices to trigger the duty to defend under the policy’s “professional services” grant.
Misappropriation exclusion: The Court interpreted “misappropriation” in its ordinary sense as using another’s property without their consent. Because the complaint did not allege M&C acted without Stewart’s authorization, Aspen could not rely on the exclusion to avoid its duty to defend. Even if “misappropriation” could be read more broadly, the term is at least ambiguous and must be construed in favor of the insured under New York law.

The Court remanded with instructions to enter partial summary judgment for M&C on Aspen’s duty to defend. It expressly did not decide whether other exclusions (notably, a “dishonest acts” exclusion) may ultimately bar indemnity or defense, nor did it address Aspen’s ultimate duty to indemnify after factual development.

Detailed Analysis

Precedents Cited and Their Role

High Point Design, LLC v. LM Insurance Corp., 911 F.3d 89 (2d Cir. 2018): Reaffirmed New York’s “exceedingly broad” duty to defend; if any claim “arguably arises” from covered events, the insurer must defend the entire action. The Court relied on this to emphasize Aspen’s heavy burden and the four corners analysis at the pleading stage.
City of Johnstown, N.Y. v. Bankers Standard Ins. Co., 877 F.2d 1146 (2d Cir. 1989): The insurer must show the underlying allegations fall “solely and entirely” within an exclusion to avoid the duty to defend. This framed Aspen’s burden regarding the misappropriation exclusion.
Lend Lease (US) Constr. LMB Inc. v. Zurich Am. Ins. Co., 28 N.Y.3d 675 (2017): Ambiguous insurance terms must be construed in favor of the insured. The Court used this canon to resolve the undefined “misappropriation” term against Aspen.
Cragg v. Allstate Indem. Corp., 17 N.Y.3d 118 (2011): Insurance contracts are construed according to common speech and reasonable expectations; exclusions are strictly and narrowly construed. This guided the Court’s plain-meaning reading of “misappropriation.”
Fitzpatrick v. American Honda Motor Co., 78 N.Y.2d 61 (1991): The duty to defend may exist even if the insurer may not ultimately be bound to indemnify. Cited to cabin the ruling to defense obligations only.
Atlantic Mut. Ins. Co. v. Terk Techs. Corp., 309 A.D.2d 22 (1st Dep’t 2003): Duty to indemnify turns on facts established, not merely pleadings. Underlines that indemnity issues are for later.
Abreu v. Huang, 300 A.D.2d 420 (2d Dep’t 2002): An insurer’s justification for denying coverage is limited to grounds stated in its disclaimer. The Court notes Aspen did not rely on the “dishonest acts” exclusion in its disclaimer (though it reserved rights), so it is not before the Court at this stage.
Beazley Ins. Co., Inc. v. ACE Am. Ins. Co., 880 F.3d 64 (2d Cir. 2018): Professional services analysis looks to whether the insured acted with “the special acumen and training of professionals.” Used to find that M&C’s actions were within the policy’s professional services grant.
Standard & Poor’s Corp., Inc. v. Commodity Exchange, Inc., 683 F.2d 704 (2d Cir. 1982); ITC Ltd. v. Punchgini, Inc., 9 N.Y.3d 467 (2007); E.J. Brooks Co. v. Cambridge Security Seals, 31 N.Y.3d 441 (2018): These unfair competition/trade secret cases illuminate that “misappropriation” involves using another’s property or rights without consent. The Court drew on these to anchor “misappropriation” in the concept of nonconsensual use.
Dean v. Tower Ins. Co. of N.Y., 19 N.Y.3d 704 (2012): The insurer bears the burden to show an exclusion applies and is not subject to any other reasonable interpretation. Employed to reject Aspen’s broad reading of “misappropriation.”
Government Empls. Ins. Co. v. Kligler, 42 N.Y.2d 863 (1977): Clear policy terms must be given plain meaning; courts avoid rewriting coverage. Supports the Court’s adherence to ordinary meaning over a policy-expanding gloss.
Zupko Painting, Inc. v. Utica First Ins. Co., 232 A.D.3d 651 (2d Dep’t 2024): Confirms the four-corners rule in assessing duty to defend; insurers cannot look outside the complaint to avoid defending. Critical because the Patterson complaint did not allege lack of client authorization.

Legal Reasoning

1) The claims “arguably arise” from professional services

The policy covers claims “by reason of an act or omission … in the performance of professional services,” defined to include services “for a client in [the firm’s] capacity as a lawyer” and services in “any similar fiduciary capacity.” The Court looked to “the nature of the conduct,” not how the claimant labeled the dispute. On the complaint’s face, M&C:

Evaluated title and represented to an auction house that the client could convey the ring “free and clear,” based on review of legal documents.
Advised on sales options, directed a private sale, and executed the sale agreement “as agent for an undisclosed principal.”
Placed proceeds into an attorney IOLA account, then managed escrow and disbursement.

These are quintessential legal and fiduciary functions requiring professional judgment. The Court also rejected Aspen’s “fee dispute” framing: the Patterson action is a judgment‑creditor enforcement suit, not a billing fight between firms. Even if fees are among the proceeds at issue, the gravamen is the firm’s professional conduct in handling client property amid creditor process.

2) The “misappropriation” exclusion does not apply at the pleading stage

The exclusion bars claims “[b]ased on or arising out of … the misappropriation of, or failure to give an account of, any asset in [the firm’s] care, custody or control, including the commingling of funds.” The policy does not define “misappropriation.”

The Court adopted the ordinary meaning: using another’s property without consent. That reading is consistent with New York’s misappropriation jurisprudence (unfair competition and trade secrets) and with the contextual focus of the exclusion (accounting/custody of client property).

Crucially, the Patterson complaint did not allege that M&C used the funds contrary to Stewart’s instructions or without her authorization. It alleged the firm’s actions were unlawful vis‑à‑vis the judgment creditor and violated a restraining notice. But a C.P.L.R. § 5222(b) restraining notice does not transfer ownership to the creditor; it proscribes transfers and supports remedies such as contempt or fraudulent conveyance. Unlawful use as to a third party is not the same as nonconsensual use as to the owner. On the four corners of the complaint, therefore, Aspen could not establish that the allegations fall “solely and entirely” within the exclusion.

Even assuming “misappropriation” could be read more broadly to reach any dishonest use of property (authorized or not), the term would be ambiguous. Under New York law, ambiguities in exclusions are strictly construed against the insurer and in favor of coverage. Thus, the exclusion cannot defeat the duty to defend.

3) Limits of the holding

The Court emphasized:

It decides only Aspen’s duty to defend—indemnity awaits factual development.
Other exclusions may matter later. Aspen reserved rights as to a “dishonest, intentionally wrongful, fraudulent, criminal, or malicious acts” exclusion but did not rely on it to disclaim the defense. Under New York’s disclaimer‑specificity rule, that ground was not before the Court.

The Dissent and the Majority’s Response

Judge Parker would enforce the exclusion. He stressed:

M&C knew of Patterson’s judgment and restraining notice yet secretly sold the ring and directed proceeds to itself and others.
The restraining notice meant the funds were not Stewart’s (or M&C’s) to use freely; taking them for the firm’s benefit was “the application of another’s property … dishonestly to one’s own use,” i.e., misappropriation.
Even accepting a “client authorization” test, the notice vitiated any “valid” authorization, so the firm acted without legitimate authorization.

The majority countered that a restraining notice bars transfer but does not change ownership; violations may be contempt or fraudulent conveyances, not theft. The complaint alleged client‑authorized handling; therefore, on a four‑corners view, “misappropriation” in its ordinary sense (nonconsensual use of another’s property) was not alleged. Whether the conduct was “dishonest” or otherwise unlawful is for other exclusions or for indemnity analysis on a factual record.

Impact and Implications

For insurers and policy drafting

Duty to defend gatekeeping: In New York, an undefined “misappropriation” exclusion cannot defeat defense obligations where the complaint does not allege use without the owner’s consent. Carriers face a heavy burden to show the allegations fall “solely and entirely” within the exclusion.
Define key terms: Expect revisions to professional liability forms to define “misappropriation” expressly (e.g., including “any unlawful or unauthorized disbursement of funds, whether or not authorized by the owner”). Absent such drafting, courts will default to ordinary meaning and contra proferentem.
Use appropriate exclusions at disclaimer: When allegations suggest fraudulent transfers, contempt, or creditor interference, carriers should evaluate and, if applicable, specifically invoke “dishonest/intentional acts,” “illegal profit/remuneration,” “fraudulent transfer,” or “willful violation of law” exclusions. New York limits defenses to grounds stated in the disclaimer.
Context matters: The Court read the exclusion’s surrounding language (“failure to give an account,” “commingling”) as targeting fiduciary accounting lapses, not every unlawful deployment of funds. Drafting that clarifies scope will influence future outcomes.

For law firms and professionals

Defense coverage more attainable: Allegations that a firm facilitated a client’s sale and disbursed proceeds at the client’s direction—even if allegedly violative of a restraining notice—will often trigger a defense, absent clearer exclusions.
Indemnity is distinct: This ruling does not immunize firms from liability. Later factual findings (e.g., knowing violation of court orders, intent to hinder a creditor) can trigger dishonest or illegal profit exclusions and may preclude indemnity.
Ethics and compliance still paramount: The opinion does not soften obligations under N.Y. R. Prof. Conduct 1.15 (safekeeping property) and creditor‑process compliance. Violations may carry sanctions regardless of insurance.

For judgment creditors

Strategic effect: Coverage for a defense may prolong litigation and settlement dynamics. Creditors should anticipate a defended adversary where complaints do not allege lack of client authorization.
Pleading considerations: If facts support it, alleging nonconsensual use or use contrary to the client’s instructions may materially alter coverage dynamics at the duty‑to‑defend stage.

Complex Concepts Simplified

Duty to defend vs. duty to indemnify:
- Duty to defend: Triggered if the complaint’s allegations, on their face, even arguably fall within coverage. It is assessed under the “four corners” of the complaint and is “exceedingly broad” in New York.
- Duty to indemnify: Depends on the actual facts proven and the policy; it is narrower and resolved later in the case.
Misappropriation (ordinary meaning): Using someone else’s property without their consent. In unfair competition and trade secret law, it similarly focuses on nonconsensual use of another’s property or rights.
C.P.L.R. § 5222(b) restraining notice: A post‑judgment device that prohibits the debtor (and certain third parties) from transferring assets; it does not transfer ownership to the creditor but supports remedies like contempt and fraudulent conveyance claims.
Contra proferentem: Ambiguities in insurance policies—especially exclusions—are construed against the insurer and in favor of the insured.
Professional services (for lawyers): Functions requiring legal training and fiduciary judgment, such as advising on title, negotiating transactions on a client’s behalf, and managing client funds in escrow or trust accounts.
Four‑corners rule: In determining the duty to defend, courts look only to the allegations within the four corners of the complaint and the policy, not extrinsic facts proposed by the insurer to avoid defense.
IOLA account: An attorney trust account for client funds held in a fiduciary capacity under New York Judiciary Law § 497.

Key Takeaways

New York’s broad duty to defend, coupled with strict construction of exclusions, favors insureds where policy terms are undefined or reasonably susceptible to multiple meanings.
“Misappropriation” in an exclusion will be read in its ordinary, consent‑based sense unless the policy provides otherwise. Client‑authorized uses of client funds—even if potentially unlawful as to third parties—do not, without more, fit that term.
Attorney facilitation of sales, provision of title assurances, and escrow/disbursement activities fall within “professional services.” Labeling a case a “fee dispute” does not erase the professional character of such conduct.
Insurers must carefully draft exclusions and expressly state all grounds for disclaimer. Reserving rights is not the same as disclaiming on a ground under New York law.
This decision is about defense, not indemnity. The outcome on indemnity may turn on later‑proven facts and on different exclusions (e.g., dishonest or illegal acts, personal profit), which were not adjudicated here.

Conclusion

Marcus & Cinelli marks a consequential clarification of two recurrent coverage questions in New York professional liability disputes. First, the Second Circuit reinforces that common lawyering functions—title assurance, transactional execution, and fiduciary handling of client funds—are “professional services” under an attorneys’ E&O policy. Second, when a policy leaves “misappropriation” undefined, courts will give the term its ordinary, consent‑based meaning and will construe any residual ambiguity against the insurer. A restraining notice may render a transfer unlawful, but it does not turn client‑authorized fund use into “misappropriation” absent allegations of nonconsensual use.

For insurers, the opinion underscores the importance of precise drafting and disclaimer specificity. For law firms, it underscores that defense coverage may be available even in difficult creditor‑enforcement contexts, while cautioning that indemnity and ethical exposure remain distinct and unresolved. As a practical precedent, the decision will likely steer future litigants toward clearer policy language and sharper pleading strategies when misappropriation and fiduciary conduct converge.