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September

2013

New York Court of Appeals Holds Insurer That Breaches Duty to Defend May Not Rely on Policy Exclusions to Escape Duty to Indemnify

Blogs, Insurance Coverage

The New York Court of Appeals recently held in K2 Investment Group, LLC, et al. v. American Guarantee Liability Ins. Co., 2013 N.Y. Slip. Op. 04270 (June 11, 2013) (a copy of the decision can be found here ), that when a liability insurer has breached its duty to defend an insured, the insurer may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him. This ruling expands a previous decision holding that an insurer which has disclaimed its duty to defend may only litigate the validity of the disclaimer. See Lang v. Hanover Ins. Co., 3 N.Y. 3d 350, 356 (2004). 

Plaintiffs, two limited liability companies, brought a lawsuit against American Guarantee and Liability Insurance Company (“American Guarantee”) in connection with loans they made to insured Goldan, LLC (“Goldan”). Golden failed to repay the loans and plaintiffs discovered that their mortgages had not been recorded. As a result, plaintiffs initially brought suit against Goldan and its two principals. In particular, plaintiffs asserted a legal malpractice claim against the principal, Jeffrey Daniels, alleging that Daniels acted as their attorney with respect to the loans made to Goldan, and that his failure to record the mortgages was a “departure from good and accepted legal practice.”

Daniels informed his malpractice carrier, American Guarantee, of the malpractice claims against him, and forwarded a copy of the complaint. American Guarantee refused to provide defense or indemnity coverage, stating that the allegations against Daniels “are not based on the rendering or failing to render legal services for others.” After this denial, plaintiffs made a settlement demand on Daniels of $450,000 – significantly less than the $2 million policy limit. Thereafter, plaintiffs obtained a default judgment against Daniels in excess of the policy limits, and solely with respect to the legal malpractice claim. Daniels assigned plaintiffs all his rights against American Guarantee. 

Subsequently, plaintiffs, as Daniels’ assignees, brought suit against American Guarantee for breach of contract and bad faith failure to settle the underlying suit. American Guarantee moved for summary judgment based on two policy exclusions, commonly referred to as the “insured’s status” and “business enterprise” exclusions. plaintiffs cross-moved for summary judgment. The trial court granted Plaintiffs’ motion as to the breach of contract claim, holding that American Guarantee breached its duty to defend Daniels, and was therefore bound, up to the $2 million policy limit, to repay the judgment against him. The trial court dismissed the bad faith claims. The Appellate Division, First Department, affirmed. See K2 Inv. Group, LLC v. American Guar. & Lia. Ins. Co., 936 N.Y.S.2d 139 (1st Dept. 2012). 

The New York Court of Appeals also affirmed, holding that, by breaching its duty to defend Daniels, American Guarantee lost its right to rely on the claimed exclusions in litigation over its indemnity obligations. The Court explained that while American Guarantee “no doubt had reason to be skeptical of the claim . . . as it is unusual, in a loan transaction, for lenders to retain a principal of the borrower to act as their lawyer,” this “only means that the claim against Daniels may have been groundless, false or baseless . . . meritless or not covered;” it did not obviate American Guarantee’s duty to defend. The court’s rationale is that this holding gives insurers an incentive to defend the cases they are bound by law to defend, and thus, gives insureds the full benefit of their bargain. The court further explains that it would be unfair to insureds, and would promote unnecessary litigation, if an insurer, having wrongfully abandoned its insured’s defense, could then require the insured to litigate the effect of policy exclusions on the duty to indemnify.