The NY Court of Appeals Will Decide Whether an Insurer Who Breaches the Duty to Defend May Contest Its Duty to Indemnify
At the K2 Re-Argument, the Court Asks: Which Rule Is Better Public Policy?
K2 Investment Group, LLC v. American Guarantee and Liability Ins. Co. shocked the coverage bar last year. On January 7, 2014, the New York Court of Appeals heard re-arguments in the case. At the rehearing, the Court implicitly acknowledged that its 2013 decision in K2 would change New York from a jurisdiction where an insurer’s breach of the duty to defend does not bar the insurer from raising coverage defenses to the duty to indemnify (the rule in the majority of jurisdictions), to one where the insurer is barred from contesting coverage. The Court’s questions to the attorneys on both sides focused to a great extent on which rule was preferable as a matter of public policy.
The insurer’s response: public policy is served by enforcing contracts as written. The duty to defend and the duty to indemnify are separate. Damages for breach of contract should leave the plaintiff no better than if the contract had been performed. Here, that means the policyholder is entitled to his costs of defense, but not to indemnification of a liability that is excluded from coverage. Anything more would be an unwarranted penalty.
The claimant’s response (as assignee of the rights of the policyholder): the insured pays premiums for litigation protection. Holding the insurer liable to indemnify the insured serves public policy by providing an incentive for the insurer to comply with its duty to defend. If the insurer believes there is no coverage it can reserve its rights and file for a declaratory judgment.
For those who are not familiar with the case: K2 made loans to a company owned by the insured. The company defaulted on the loans. The insured was an attorney with a lawyer’s professional liability policy, and K2 claimed that he committed legal malpractice by not recording mortgages to secure the loans (which he had also personally guaranteed). After the insurer declined to defend K2’s suit, relying on exclusions for liability arising out of the insured’s management of a business other than the insured’s law practice, the insured defaulted, and a judgment entered on the malpractice claim. The claims based on the insured’s personal guarantees were dismissed.
The notion that the insured attorney was representing a client on the other side of a business transaction in which he was a participant strains credulity, and suggests that the malpractice claim was a weak effort to reach an otherwise insolvent defendant’s legal malpractice coverage. Of course, this doesn’t mean that the policyholder was not entitled to a defense. And, as the Court observed during the re-argument, the insurer has not alleged that there was any collusion between the policyholder and the claimant. But, as is frequently the case in this area, the equities are complicated by the fact that K2 was pleading to the coverage.
If the Court elects to decide the case based on stare decisis, the insurer should win; the questions during the re-argument validated the insurer’s position that, under Servidone Constr. Corp. v. Security Ins. Co. of Hartford, 64 N.Y. 2d 419 (1985), the insurer should not have been barred from contesting indemnification. The Court gave short shrift to K2’s argument that Servidone only applied to cases where the underlying liability was in the form of a settlement, rather than a judgment. But the Court clearly has in mind its option to overrule Servidone, if it is convinced that the minority rule is better law.
The case is K2 Investment Group, LLC v. American Guarantee and Liability Ins. Co., N.Y. Ct. App. slip op. 04270 (2013).
Posted In: Duty to Indemnify