Insurer May Not Rely On Policy Exclusions to Defeat Its Duty to Indemnify an Insured Where the Insurer Breaches Its Duty to Defend
The New York State Court of Appeals recently considered the issue of an insurer’s duty to defend its insured against a liability claim. K2 Investment Group, LLC, et. al. v American Guarantee & Liability Insurance Company, 213 N.Y. LEXIS 1461, June 11, 2013.
The plaintiffs made loans totaling 2.83 million dollars to Goldan, LLC. Goldan defaulted on the loans, and ultimately went bankrupt. Plaintiffs sued Goldan and its principals, Mark Goldman and Jeffrey Daniels. One of the claims asserted by plaintiffs against Daniels, a lawyer, was for legal malpractice. Plaintiffs alleged that Daniels was their attorney with respect to the loans, and that he failed to record their mortgages.
Daniels notified his professional legal liability carrier, American Guarantee & Liability Insurance Company (“American Guarantee”) and forwarded a copy of the complaint. American Guarantee disclaimed any obligation to defend or indemnify Daniels.
Following the disclaimer, plaintiffs submitted a settlement demand to Daniels for $450,000, which was significantly less than the $2,000,000 limit of liability coverage under American Guarantee’s policy. Daniels submitted the demand to American Guarantee which rejected it.
Daniels defaulted in the action against him, and the plaintiffs obtained a default judgment in excess of the American Guarantee policy limit based upon the plaintiffs’ legal malpractice claim. Plaintiffs’ other claims against Daniels were discontinued.
Daniels assigned plaintiffs his rights against American Guarantee. Plaintiffs then brought suit against American Guarantee for breach of contract and bad-faith failure to settle the underlying lawsuit. Plaintiffs sought to recover the $2,000,000 policy limit as well as the full amount of their default judgment in excess of the policy limit.
American Guarantee moved for summary judgment, relying on two policy exclusions, the so-called “insured’s status” and “business enterprise” exclusions.
The policy issued by American Guarantee provided, in part:
This policy shall not apply to any Claim based upon or arising out of, in whole or in part . . .
D. the Insured’s capacity or status as:
1. an officer director, partner, trustee, shareholder, manager or employee of a business enterprise . . .
E. the alleged acts or omissions by an Insured, with or without compensation, for any business enterprise, whether for profit or not-for-profit, in which any Insured has a Controlling Interest.
American Guarantee contended that the claim against Daniels arose out of his “capacity or status” as a member, owner and manager of Goldan, as well as his “acts or omissions” on Goldan’s behalf.
Plaintiffs cross-moved for summary judgment. Supreme Court granted plaintiffs’ motion as to the breach of contract claims, finding that American Guarantee breached its duty to defend Daniels, and was bound up to the $2,000,000 limit of its policy.
On appeal, the Appellate Division, First Department, affirmed with two Judges dissenting in part. The majority of the Appellate Division found that the exclusions relied on by American Guarantee were inapplicable to the malpractice claim on which the default judgment was based. American Guarantee appealed to the Court of Appeals.
The Court of Appeals affirmed without reaching the question of whether the policy’s status and business enterprise exclusions were applicable. The Court of Appeals stated:
We hold that, by breaching its duty to defend Daniels, American Guarantee lost its right
to rely on these exclusions in litigation over its indemnity obligation.
The Court cited its prior holding in Automobile Insurance Company of Hartford v Cook, 7 N.Y.3d 131, 137 (2006), addressing the issue of an insurer’s duty to defend, which held that:
The duty to defend is exceedingly broad, and an insurer will be called upon to provide a defense whenever the allegations in the complaint suggest a reasonable possibility of coverage. If, liberally construed, the claim is within the embrace of the policy, the insurer must come forward to defend its insured, no matter how groundless, false or baseless the suit may be.
The Court noted that the complaint in the lawsuit against Daniels “unmistakably pleads a claim for legal malpractice.”
The Court cited another of its decisions, Lang v. Hanover Insurance Company, 3 N.Y.3d 350 (2004), where it stated:
[A]n insurance company that disclaims in a situation where coverage may be arguable, is well advised to seek a declaratory judgment concerning the duty to defend or indemnify the purported insured. If it disclaims and declines to defend in the underlying lawsuit without doing so, it takes the risk that the injured party will obtain a judgment against the purported insured and then seek payment … Under those circumstances, having chosen not to participate in the underlying lawsuit, the insurance carrier may litigate only the validity of its disclaimer, and cannot challenge the liability or damages determination underlying the judgment . . . 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 . . . This rule will give insurers an incentive to defend the cases they are bound by law to defend, and thus to give insureds the full benefit of their bargain. It would be unfair to insureds, and would promote unnecessary and wasteful litigation, if an insurer, having wrongfully abandoned its insured’s defense, could then require the insured to litigate the affective policy exclusions on the duty to indemnify.
The Court affirmed the lower court’s dismissal of plaintiff’s claim alleging American Guarantee’s bad-faith failure to settle the malpractice claim against Daniels when it had the opportunity. The Court noted that there was nothing in the record to suggest that the insurer knew or should have known that the malpractice claim was worth more than the $450,000 demand, “let alone more than the $2,000,000 policy limit.” The Court declined to decide whether an allegation of bad-faith failure to defend could ever support a claim for damages in excess of the policy limits.
This decision is a further extension of the Court’s broad interpretation and application of an insurer’s duty to defend its insured. The Court is announcing to insurers that disclaiming a duty to defend is at the insurer’s peril since it will have waived any applicable policy exclusions barring certain public policy arguments, such as an intentional act by an insured. Extreme caution must be exercised in these coverage evaluations and decisions regarding the duty to defend in order to preserve all coverage defenses.
If you require further information regarding the information presented in this Legal Alert and its impact on your organization, please contact Anthony J. Piazza, Chair of the firm’s Insurance Coverage & Regulation Practice Area, at (585) 295-4420 or firstname.lastname@example.org.