| August 2013 |
Volume 25, Number 8 |
A Review of the Recent Court of Appeals Decision
Regarding Duty of an Insurer to Defend
When an insurer denies an insured’s claim, agents and brokers often are tempted to intercede on the insured’s behalf to help them argue in favor of coverage. Generally, we recommend against an agent or broker becoming closely involved in any coverage dispute between the insured and the insurer. A statement made or an email written by an agent or broker to an insurance company explaining why an insured should have coverage for a particular loss often becomes a key piece of evidence in a subsequent errors and omissions claim or lawsuit against the agent or broker. However, reference to the Court of Appeals' decision in the recent case of K2 Investment Group LLC v. American Guarantee & Company, 2013 N.Y. Sip.Op. 04270 (June 11, 2013) may provide insureds greater leverage to at least obtain a defense in a lawsuit, without the need for the agent or broker becoming involved in the underlying coverage issues.
As you may be aware, the duty to defend under a liability policy is broader than the duty to indemnify. While an insurance company is only required to indemnify its insured for liability that actually falls within the scope of coverage under the policy, the insurer typically owes a duty to provide its insured with a defense in a lawsuit, if the lawsuit includes allegations which, if proven, would be covered under the policy. This generally remains true even if the insurance company is aware of facts that suggest that the claim ultimately will not fall within the scope of the policy.
An insurance company frequently will owe a duty to defend even in the absence of a duty to indemnify. Prior to the K2 decision, however, insurers did not always have much incentive to do so under New York law. This was especially true since an insurer that did not provide a defense would suffer no penalty or adverse effects if it was later found to owe such obligation. To the contrary, it has been almost beneficial to an insurance company to refuse to provide a defense because the insured was then forced to hire an attorney to bring suit against the insurer to attempt to enforce such coverage. A successful insured would bear its own litigation costs in the declaratory judgment action. As a result, an insured with little financial means to fund a declaratory judgment action would likely be better served spending those funds defending the underlying lawsuit, lest the insured face the possibility of bearing two sets of attorneys' fees in the end.
On the other hand, New York law provides that an insurance company that brings a declaratory judgment action against its insured and is then ultimately found to owe coverage will be obligated to reimburse its insured's attorneys' fees in defending that declaratory lawsuit. In a situation where the duty to defend was questionable, an insurance company might have considered providing a defense and bringing a declaratory judgment action seeking to declare it did not owe coverage. The potential for facing attorneys' fees often chilled that thought. If, instead, the insurance company waited to see if the insured brought suit and took its chances on the coverage determination, a losing insurer would, at worst, be obligated to reimburse its insured for the defense the insurance company had owed in the first instance. In other words, the insurance company would ultimately be no worse off by taking a "wait and see" position.
The recent Court of Appeals decision in the K2 case changes this equation by providing a disincentive to insurance companies who fail to provide a defense in a questionable situation. Under the decision in the K2 case, “when a liability insurer has breached its duty to defend its insured, the insurer may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him.” New York insurance agents and brokers familiar with Connecticut law may already know this type of rule, as it is similar to the rule set forth by the Connecticut Supreme Court in the case of Missionaries of the Company of Mary, Inc. v. Aetna Casualty and Surety Co., 155 Conn. 104 (1967). In short, an insurance company that breaches its duty to defend, may find itself barred from asserting an otherwise valid exclusion and, therefore, owing a duty to indemnify even where none would otherwise exist. We note the New York Court of Appeals has only specifically applied this rule so far to prevent a carrier from asserting a policy exclusion. The courts have not addressed whether this would stop a carrier from asserting an otherwise valid condition or asserting a defense that the claim does not fall within the scope of coverage.
In appropriate circumstances, this new rule can provide leverage to help an insured obtain a defense when the insurance company is dragging its feet. While the insurance company will likely only provide a defense subject to a reservation of rights, this, in and of itself, can be quite valuable, as defense costs can add up quickly. Moreover, an insurance company that is already providing a defense is often more willing to contribute to a settlement, if only to avoid the cost of continuing its defense of the insured.
By informing your insureds facing this situation of this new development in the New York law, you may be able to help them obtain a defense from an otherwise unwilling insurance company without the need for addressing any of the issues relating to the coverage itself. However, we caution that this should not become a springboard for discussing the merits of the coverage issues, but merely a means of pointing out to the insurance company that it faces the possibility of being wrong on its coverage defense, and therefore losing the right to assert it. Not only will this help your insureds, but it may help the agency or brokerage avoid a potential E&O claim or lawsuit.
Keidel, Weldon & Cunningham, LLP concentrates its practice in the defense of insurance agents and broker’s errors and omissions claims and litigation, errors and omissions loss control counsel and education, insurance coverage analysis and litigation and insurance regulatory matters. Please direct any comments or questions to James C. Keidel, Esq. by mail to the main office of Keidel, Weldon & Cunningham, LLP, at 925 Westchester Avenue, Suite 400, White Plains, NY 10604, telephone at (914) 948-7000 or e-mail at jkeidel@kwcllp.com. The law firm also maintains offices in Syracuse, New York; New York City, New York; Wilton, Connecticut; Bayonne, New Jersey; Warwick, Rhode Island and Philadelphia, Pennsylvania.
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