Reed Smith Client Alert

Authors: John N. Ellison

Policyholders received a boost of support from a New York Court of Appeals on Tuesday when the court held that an insurer is precluded from using policy exclusions as a means to escape its duty to indemnify a claim if it previously breached its duty to defend its policyholder by improperly denying coverage. The Court of Appeals handed down this ruling in K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co., Case No. 106, affirming summary judgment in the plaintiff’s favor on its breach of contract claims.

The defendant insurer in K2 Investment refused to provide its attorney policyholder a defense or indemnification in connection with an underlying legal malpractice lawsuit brought against him. Following the insurer’s refusal to provide coverage, the plaintiffs in the underlying action obtained a default judgment against the policyholder which was in excess of the insurance policy limits. The policyholder then assigned his rights against his insurer to the underlying plaintiffs who then brought an action against the insurer for breach of contract and bad faith failure to settle the underlying action. When the insurer attempted to escape its indemnification obligation by pointing to various policy exclusions, the Supreme Court held, and Appellate Division affirmed, that the insurer breached its duty to defend in the underlying action and was, therefore, bound to pay the full policy limits.

The Court of Appeals explained that its decision in K2 Investment did not mark a change in New York insurance law, but instead clarified a previous decision in Lang v. Hanover Inc. Co., 3 N.Y.3d 350, 356 (2004), wherein the court held that if an insurer refuses to defend its insured in an underlying action, the insurer "may litigate only the validity of its disclaimer" in a subsequent coverage action.

The result of the Court of Appeals’ clarification on the Lang duty to defend ruling means that insurers must be more cautious before denying a policyholder’s request for a defense when it is a close call. If such a denial is later found to be improper, the insurer will be obligated to provide coverage for any resulting judgment or settlement against its policyholder regardless of any policy exclusions that would have avoided indemnification. Policyholders should now receive the benefit of any doubt when it comes to an insurer’s decision whether to provide a defense and will be far more likely to obtain their defense benefits under their insurance policy that they purchased.

Although the Court of Appeals decision in K2 Investment represents a big step for policyholders in New York, the decision actually embraces an estoppel rule for breach of the duty to defend that other courts across the country, such as Illinois, have recognized for years. Now, New York policyholders, and insurance policies governed by New York law, will indisputably receive the same protections.


Client Alert 2013-159