A federal appeals court has ruled that Allied World Specialty Insurance Company wrongly refused to defend a policyholder against workplace sexual harassment claims.
On April 6, 2026, the Ninth Circuit reversed a lower court decision that had sided with Allied, finding the insurer breached its duty to defend, acted in bad faith as a matter of law, and violated Washington state's Insurance Fair Conduct Act.
The case traces back to a state court complaint filed by four individuals – Billy Bramblett, James Lacey, Dion Lumadue, and Nicholas Knaack – against American Behavioral Health Systems (ABHS). The complaint alleged sexual harassment, gender discrimination, and related misconduct in the workplace. After the plaintiffs reached a settlement with ABHS in August 2023, ABHS assigned its rights under the Allied insurance policy to the plaintiffs, who then turned around and sued the insurer directly.
At the heart of the dispute is a tension baked into the policy itself. On one hand, the policy explicitly covers losses from claims alleging sexual harassment, unwelcome sexual advances, requests for sexual favors, or other misconduct of a sexual nature. On the other, a Sexual Abuse Exclusion strips away coverage for any claim alleging, arising out of, based upon, attributable to, or in any way relating to actual or alleged sexual molestation or sexual abuse. A third provision, Endorsement 12, states that Allied has a duty to defend any claim covered in whole or in part under the policy – even if the claim is groundless, false, or fraudulent.
Allied took the position that the exclusion wiped out coverage for the entire complaint because the sexual harassment allegations were too intertwined with the sexual abuse allegations to be separated. The district court agreed, granting summary judgment in Allied's favor across the board.
The Ninth Circuit saw it differently. Applying Washington state law, which requires exclusions to be read narrowly against the insurer and ambiguities to be resolved in favor of triggering the duty to defend, the court found the complaint could be divided into covered and excluded portions in at least two ways.
First, the court noted that a jury could impose liability on certain causes of action based solely on covered allegations. A gender discrimination claim under the Washington Law Against Discrimination, for example, could rest entirely on allegations of verbal harassment without touching any sexual abuse allegations.
Second, the court looked at the plain meaning of the undefined terms "sexual molestation" and "sexual abuse" in the exclusion. Drawing on dictionary definitions, the court observed that both terms, read narrowly, require physical sexual contact and force. Several of plaintiff Knaack's allegations – verbal sexual advances, strip searches that involved no physical touching, and unwanted hugging – did not clear that bar. Those allegations remained covered, and that partial coverage was enough to trigger the duty to defend under Endorsement 12.
The court also pushed back on Allied's broad reading of the phrase "relating to" in the exclusion. While the term extends the exclusion's reach beyond what "arising out of" alone would cover – potentially capturing post-abuse negligence, for instance – the court held it does not stretch far enough to sweep in separately covered sexual harassment claims.
Having found that Allied should have defended ABHS, the court went further. It ruled that Allied's denial was not just wrong but unreasonable – constituting bad faith as a matter of law. The insurer, the court found, resolved ambiguities in its own policy in its own favor rather than in favor of the insured, which Washington law does not permit. As a consequence, the plaintiffs are entitled to coverage by estoppel for the full amount of the underlying settlement. In practical terms, Allied cannot now deny coverage at all.
The court also found Allied liable under Washington's Insurance Fair Conduct Act, which allows claims against insurers who unreasonably deny coverage. On remand, the district court will decide whether to impose additional remedies, potentially including treble damages and attorney fees.
Not everything went the plaintiffs' way. A separate claim under the Washington Consumer Protection Act was sent back to the lower court for further proceedings because the plaintiffs had not yet shown they met all the required elements. And claims based on alleged violations of procedural insurance regulations did not survive the appeal – the court found no evidence those violations caused the plaintiffs any harm, and the IFCA does not create a standalone cause of action for regulatory violations.
The case now returns to the Western District of Washington, where District Judge Barbara Jacobs Rothstein will oversee the next phase. That includes the entry of summary judgment for the plaintiffs on the bad faith claim, partial summary judgment on the duty to defend and IFCA claims as to liability, and a determination of damages.
For insurers whose policies cover workplace harassment claims, the decision is a pointed reminder of how Washington courts handle the collision between coverage grants and exclusions. When a policy covers sexual harassment but excludes sexual abuse, and a complaint contains allegations of both, a blanket denial of defense carries serious risk. The consequences Allied now faces – liability for bad faith, estoppel from denying coverage entirely, and potential treble damages – illustrate just how steep that risk can be.
