New York High Court Reverses Course; Allows Carriers to Rely on Policy Exclusions Where Duty to Defend was Breached

    19 February 2014

    K2 Investment Group, LLC. v. American Guarantee & Liability Ins. Co., No. 6, 2014 N.Y. LEXIS 201 (N.Y. Ct. of App. Feb. 18, 2014).

    In 2013, the New York Court of Appeals affirmed an order granting summary judgment to a policyholder’s assignee against an insurance company in a case seeking indemnification for a legal malpractice judgment against the original policyholder. K2 Inv. Grp., LLC v. Am. Guar. & Liab. Ins. Co., 21 N.Y.3d 384 (2013) (K2-1). The Court found that the insurance company’s refusal to defend the case was a breach of the duty to defend under the policy and, therefore, precluded the insurance company from relying on policy exclusions to defeat a claim seeking indemnity for the judgment rendered against the policyholder. As might be expected, the insurance industry was up in arms over this decision, which it was said would have a profound effect on the ability of insurance companies to disclaim on the duty to defend.

    After granting the insurance company’s motion for reargument, the Court changed course, vacated its earlier decision and reversed the order granting summary judgment. It did so in a four to two opinion, relying heavily on its 1985 decision in Servidone Const. Corp. v. Sec. Ins. Co. of Hartford, 64 N.Y.2d 419 (1985).

    In Servidone, the insurance company was also relying on policy exclusions to defend against a suit for indemnification. A settlement ensued and the Court held that even though the insurance company breached its duty to defend, it was not liable to indemnify the policyholder where coverage was disputed.

    In reaching its decision to vacate K2-1, the court laid out an important rule for the insurance industry:

    When our Court decides a question of insurance law, insurers and insureds alike should ordinarily be entitled to assume that the decision will remain unchanged unless or until the Legislature decides otherwise.

    The conclusion above was central to the analysis of K2-1 and Servidone. The Court noted early on in its opinion that Servidone and K2-1 could not be reconciled. Thus, the Court had to either overrule Servidone or follow it. The Court chose to follow it.

    The Court rejected that there was any meaningful distinction between the settlement in Servidone and the judgment in K2-1. As the Court said, “[a] liability insurer’s duty to indemnify its insured does not depend on whether the insured settles or loses the case.” Where the insurance company is not seeking to relitigate the issues of the underlying case after breaching its duty to defend, the question becomes whether the insurance company may rely on policy exclusions that do not depend on the facts established in the underlying litigation. With Servidone as precedent, and with its approach being followed in several jurisdictions, the Court saw no justification for overruling Servidone.

    The insurance company’s task of evaluating a claim and determining whether it must defend that claim is difficult when faced with the extreme time pressure associated with a carrier’s ability to disclaim or reserve rights. Courts have made it clear that the duty to defend is much broader than the duty to indemnify. If a refusal to defend under a duty-to-defend policy would automatically foreclose the insurance company from being able to rely upon policy exclusions should a subsequent action find that the insurance company breached its duty to defend, then it would be nearly impossible for an insurance company to refuse to defend any claim. With this opinion, the New York Court of Appeals allows insurance companies to breathe a sigh of relief. 

    Should you have any questions regarding this Client Alert or are interested in hearing more about this topic or the cases discussed, please contact the author or a member of the Insurance & Reinsurance Practice.