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K2_7_31_13_NYLJ (00161372).PDF


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K2_7_31_13_NYLJ (00161372).PDF

  1. 1. I n a decision being discussed virally all over the Internet, the New York Court of Appeals in K2 InvestmentGroupv.AmericanGuarantee&Liabil- ity Ins.1 broadly announced the following in the first sentence of its opinion: “[w]hen a liability insurerhasbreacheditsdutytodefenditsinsured, theinsurermaynotlaterrelyonpolicyexclusions to escape its duty to indemnify the insured for a judgmentagainsthim.”2 Applyingthisprinciple,the CourtofAppealsaffirmedtheinjuredparties’right torecoverfromtheinsurertheamountofadefault judgment entered against the insured. The court held that, having breached its duty to defend the insured, the insurer could not rely on two exclu- sions to escape its duty to indemnify, and thus, could not raise these defenses in a direct action suit by the injured parties. How radical is this? As it turns out, very…and not so much. On the one hand, the court silently rejected a basic principle which it had embraced almost 30 years ago in Servidone Const. v. Security Ins. of Hartford3 —namely, that “an insurer’s breach of [its] duty to defend does not create coverage.”4 On the other hand, the Court of Appeals merely added to an already existing list of scenarios in which the insurer may lose rights that bear on the duty to indemnify. The precise reach of K2 Investment’s holding is still to be determined. For example, K2 Invest- ment left standing some exceptions for claims based on the insured’s intentional misconduct or for collusion between the insured and injured party.Moreover,K2 Investmentdoesnotexpressly address what happens if a claim falls outside the purview of the Insuring Agreement. On the same date that the Court of Appeals issued its decision, the U.S. Court of Appeals for the Second Circuit did expressly address this issue in CGS Industries v. Charter Oak Fire Ins.5 and upheld the insurer’s right to deny the duty to indemnify even though it breached its duty to defend—citing Ser- vidone. The tensions between CGS, K2 Investment and Servidone are illustrated by recent events: a rehearing has been requested in CGS based on K2 Investment, while reargument has been requested in K2 Investment based on Servidone with a nod to CGS. Whether CGS will survive K2 Investment is unclear, but the two decisions may be reconciled for now. At this point, what is clear is that insurers must be more vigilant in assessing whether they have a duty to defend, especially when exclusions are in play, so as not to jeopardize their ability to deny the duty to indemnify. Life Before and After‘K2’ Prior to the Court of Appeals’ opinion in K2 Investment, there were already a myriad of sce- narios in which the insurer could lose some right that bears on the duty to indemnify: •Aninsurerthatfailstotimelydisclaimcoverage underNewYorkIns.Law§3420(d)(2)losestheright to raise an exclusion or condition of coverage.6 • An insurer that breaches its duty to defend loses the right to deny indemnification based on the policy’s voluntary payment condition for an insured’s reasonable settlement.7 • An insurer may be estopped to deny cov- erage by defending without properly reserving its rights.8 In one sense, K2 Investment merely adds to this existing list, although in a very substantial way: • An insurer who breaches its duty to defend may not raise an exclusion to deny the duty to indemnify its insured, at least where a judgment has already been obtained. The K2 Investment principle would almost cer- tainly apply to a reasonable settlement (which was what was involved in Servidone). What About‘Servidone’? The question many have been is asking is, why did the Court of Appeals not even mention its prior decision in Servidone, which it implic- itly overrules? In Servidone, an employee of the insured (Servidone Construction Corporation) was injured in a construction accident and sued the owner (the United States), which in turn impleaded Servidone based on common law and contractual indemnity. Servidone’s insurer (Security Insurance Company) agreed to defend but took the position that the con- tractual indemnification claim was excluded. However, when a pretrial order was entered characterizing the third-party action as one for contractual indemnity, Security withdrew from the defense based on the contractual liability exclusion. Servidone entered into a settlement. Neither Security’s breach of its duty to defend nor the reasonableness of the settlement was disputed.9 The issue was whether an insurer could deny its duty to indemnify its insured for a settle- ment based on a policy exclusion. The court said “yes”: [A]n insurer’s breach of [its] duty to defend does not create coverage and…even in cas- es of negotiated settlements, there can be no duty to indemnify unless there is first a covered loss. Since the loss compromised by Servidone was not determined to be within the covered risks, we reverse the order awarding Servidone the full settle- ment amount and remit the case for further proceedings.10 The court remanded the case for a trial on whether the exclusion was applicable, with the burden of proof on the insurer.11 In K2 Investment, while the facts are distin- guishable, they are not so in any meaningful way withrespecttothecourt’sultimateholding.Plain- tiffs, two LLCs, loaned money to Goldan, LLC, a real estate company owned by the insured, attor- ney Jeffrey Daniels, and Mark Goldman. Plaintiffs claimed that Daniels agreed to represent them in SERV ING THE BE NCH AND BAR SINCE 1 888 VOLUME 250—NO. 22 WEDNESDAY, JULY 31, 2013 ‘K2 Investment Group’ Ruling: Radical…or Not? Outside Counsel Expert Analysis MICHAELS.GOLLUBisamember,andSTEVENM.ZIOLKOWSKI is an associate, with the insurance coverage group of Marshall, Conway & Bradley. WWW.NYLJ.COM By Michael S. Gollub And Steven M. Ziolkowski Insurers now need to be more care- ful before refusing to defend, espe- cially when relying on policy exclu- sions, so as to not jeopardize their ability to deny the duty to indemnify.
  2. 2. the transaction and committed attorney malprac- tice by failing to record mortgages securing the loans or obtain title insurance. Daniels placed his own malpractice carrier (American Guarantee and Liability Insurance Company) on notice, and American reserved its rights to deny coverage based on, among other things, an Insured’s Status Exclusion and a Business Enterprise Exclusion. After plaintiffs commenced a lawsuit assert- ing malpractice and other claims, American retained counsel to represent Daniels but then withdrew based on, among other things, the foregoing exclusions. A default judgment was enteredagainstDanielsonthemalpracticeclaims only, and Daniels assigned his rights as against American to plaintiffs. Plaintiffs brought suit against American to, among other things, enforce the default judg- ment pursuant to New York Ins. Law §3420. The First Department affirmed the Supreme Court’s entry of judgment in favor of plaintiffs against American. In doing so, it considered applica- tion of the exclusions but held that they did not apply.12 The Court of Appeals affirmed, but on other grounds. In doing so, it transformed the issue to one similar to that considered in Servidone: whether an insurer could raise policy exclusions to deny its duty to indemnify the insured (and thus the injured parties-judgment creditors) for a default judgment. This time, the court said “no,” with some exceptions,13 purporting to explain a previous statement made in Lang v. Hanover Ins.14 that “having chosen not to participate in the underlying lawsuit the insurance carrier may litigate only the validity of its disclaimer….”15 While Lang did not involve a situation like the one we have here, we now make clear that Lang, at least as it applies to such situations, means what it says: an insurance company that has disclaimed its duty to defend “may litigate only the validity of its disclaimer.” If the disclaimer is found bad, the insurance company must indemnify its insured for the resulting judgment, even if policy exclusions would otherwise have negated the duty to indemnify.16 The Court of Appeals’ observation that Lang “did not involve a situation like the one we have here” is quite an understatement: The primary issue in Lang was whether an injured party had the right to seek declaratory relief against the tortfeasor’s insurer prior to obtaining a judgment against the tortfeasor (the answer is “no”). The statement that the Court of Appeals purported to clarify was contained in dicta at the end of the Langdecisiongivinggratuitousadvicetoinsurers. Servidone, however, did “involve a situation liketheonewehave”in K2 Investment,exceptthat Servidone involved a settlement while K2 Invest- ment involved a default judgment. As applied to the court’s broad pronouncement in K2 Invest- ment, this is a distinction without a difference. If the Court of Appeals intended to overrule Servidone, it should have expressly done so. So why did the Court of Appeals not even mention Servidone? Who knows. Although Servidone was cited generally in the appellate briefs, it was not raised by counsel in oral argument.17 The law- yers out there can surely remember at least one class in which a professor questioned why even the U.S. Supreme Court failed to distinguish an important, seemingly controlling precedent. So here is another example of that, this time out of the classroom. Notsurprisingly,theCourtofAppealshasbeen asked to reconsider its decision, in part based on its failure to discuss Servidone. What About‘CGS’Decision? On the same date that the Court of Appeals decided K2 Investment, the Second Circuit issued a seemingly conflicting decision in CGS. However, for now, the two decisions may be reconciled. As discussed above, K2 Investment involved policy exclusions. In contrast, in CGS, the court addressed whether a lawsuit alleged “advertising injury” within the Insuring Agreement, answering “yes” for the duty to defend but “no” for the duty to in-demnify. Specifically, Five Four Clothing Inc., sued Wal-Mart Stores Inc. and CGS Industries Inc. for trademark infringement based on distinctive “FF stitching” on jeans supplied by CGS to Walmart. CGS’s insurer, Charter Oak Fire Insurance Com- pany, refused to defend CGS, claiming that the lawsuit was not within the policy’s “advertising injury” coverage and was excluded. CGS settled the underlying lawsuit and commenced a lawsuit against Charter. The court applied a two-tiered analysis, hold- ing that whether the FF stitching was “advertis- ing injury” as infringement of “title” was legally uncertain enough to trigger Charter’s duty to defend, but clear enough that it was not “adver- tising injury” to bar its duty to indemnify.18 The court thus held that Charter was not obliged to indemnify the insured for settlement of the lawsuit, relying in part on Servidone: As noted above, the complaint in the Under- lying Action alleged a potentially uninten- tional infringement of title in the course of advertising that triggered Charter’s duty to defend the entire action. Charter’s breach of that duty does not entail an obligation to pay the settlement amount in the absence of a duty to indemnify. “The narrow duty to indemnify arises only if the claim for which the insured has been judged liable lies within the policy’s coverage.” …In Ser- vidone Construction, the New York Court of Appeals held that “an insurers breach of [its] duty to defend does not create coverage and that, even in cases of negotiated settle- ments, there can be no duty to indemnify unless there is first a covered loss.” …As noted above, while the uncertainty around the meaning of “title” gave rise to a duty to defend, there was not sufficient ambiguity to give rise to a duty to indemnify, and Charter is therefore not liable for CGS’s settlement.19 Of course, had the Second Circuit known about the Court of Appeals decision in K2 Invest- ment one would have expected it to distinguish that latter case, perhaps on the grounds that K2 Investment involved policy exclusions and not the Insuring Agreement. Then again, one would have expected the Court of Appeals to distinguish Servidone. Notably, CGS has filed a petition for rehearing based on, in part, citation to K2 Investment. This all leaves insurers on uncertain ground. Insurers now need to be more careful before refusing to defend, especially when relying on policy exclusions, so as to not jeopardize their ability to deny the duty to indemnify. ••••••••••••••••••••••••••••• 1. 2013 N.Y. LEXIS 1461 (June 11, 2013). 2. K2 Investment, 2013 N.Y. LEXIS 1461, at *1. 3. 64 N.Y.2d 419 (1985). 4. Servidone, 64 N.Y. at 423. 5. 2013 U.S. App. LEXIS 11700 (2d Cir. June 11, 2013). 6. See Handelsman v. Sea Ins., 85 N.Y.2d 96, 99 (1994); Zappone v. Home Ins., 55 N.Y.2d 131, 135-137 (1982) (interpreting predeces- sor statute). 7. See Isadore Rosen & Sons v. Security Mut. Ins. of New York, 31 N.Y.2d 342, 347 (1972); Cardinal v. State of New York, 304 N.Y. 400, 410-11 (1952), cert. denied, 345 U.S. 918 (1953). 8. See Albert J. Schiff Associates v. Flack, 51 N.Y.2d 692, 699 (1980). 9. Servidone, 64 N.Y.2d at 423. 10. Servidone, 64 N.Y.2d at 423. 11. Servidone, 64 N.Y.2d at 425. 12. See K2 Investment v. American Guarantee & Liability Ins., 91 A.D.3d 401, 402-03 (1st Dept. 2012). Two Justices dissented, arguing that there were fact issues over application of the exclu- sions. 13. As mentioned, the court left open the possibility that an insurer could still disclaim its duty to indemnify for the insured’s intentional misconduct or if there was collusion between the in- sured and injured party. K2 Investment, 2013 N.Y. LEXIS 1461, *6, *8-*9. 14. 3 N.Y.3d 350 (2004). 15. Lang, 3 N.Y.3d at 356. 16. K2 Investment, 2013 N.Y. LEXIS 1461, *8. 17. This may be explained by the fact that the Court of Appeals essentially recast the issue on appeal, from how a default judg- ment applies to determining the applicability of exclusions for the duty to indemnify, to whether the insurer can even raise the exclusions having breached the duty to defend. 18. CGS, 2013 U.S. App. LEXIS 11700, *15-*22. 19. CGS, 2013 U.S. App. LEXIS 11700, *27-*28. The court ad- opted this two-tiered analysis from its previous decision in Hugo Boss Fashions v. Fed. Ins., 252 F.3d 608 (2d Cir. 2001). In that case, then Circuit Judge Sonia Sotomayor dissented, noting that “[t] he majority’s attempt to establish a two-tiered standard for le- gal clarity—requiring ‘unambiguous’ legal terms to disclaim the duty to indemnify, but requiring unambiguous legal terms that courts will recognize with certainty to disclaim the duty to de- fend—finds no basis in New York law.” Hugo Boss, 252 F.3d at 626. On its surface, K2 Investment appears to adopt Sotomayor’s dis- sent by applying one standard for the duty to defend and duty to indemnify, holding that when the former is breached the latter is also effectively “breached” (or, really, triggered). However, there is one important distinction: Sotomayor in Hugo Boss would have held that there was no duty to defend under the facts of that case. It is not at all certain that, had Sotomayor concluded there was a duty to defend, the judge would have further reached the conclu- sion reached in K2 Investment, that there was a duty to indemnify just because there was a breach of the duty to defend. WEDNESDAY, JULY 31, 2013 Not surprisingly, the Court of Ap- peals has been asked to reconsider its decision, in part based on its fail- ure to discuss‘Servidone.’ Reprinted with permission from the July 31, 2013 edition of the NEW YORK LAW JOURNAL © 2013 ALM Media Properties, LLC. All rights reserved. Further duplication without permission is prohibited. For information, contact 877-257-3382 or reprints@alm. com.#070-08-13-11