The New York Court of Appeals, in K2 Investment Group, LLC v. American Guarantee & Liability Insurance Company, 2014 WL 590662 (N.Y.), 2014 N.Y. Slip Op. 01102 (N.Y. Feb. 18, 2014), has vacated its own prior decision, reversed the Appellate Division’s order and held that where an insurer breaches a contractual duty to defend its insured in a personal injury action, and the injured party obtains a judgment against the insured, the insurer is not liable to indemnify the insured when coverage is disputed.
Ruling on February 18, the court stated that this remains true whether it was a settlement with the injured party or judgment against the insured. The court correctly explained that “a liability insurer’s duty to indemnify its insured does not depend on whether the insured settles or loses the case.”
The Court of Appeals’ prior ruling, last June, appeared to hold that when an insurer breaches its duty to defend, that insurer would automatically owe indemnity coverage for which it had never charged a premium for and which the policy never actually covered.
The new decision reverses course and recognizes no rational reason for departing from the well-established rule of New York law set forth in Servidone Construction Corporation v. Security Insurance Company, 64 N.Y.2d 419 (N.Y. 1985). In Servidone, the court held that when an insurer makes a mistake and wrongfully denies a defense that insurer is not precluded from asserting its defenses to coverage for indemnity.
Although knowledge of the underlying facts is not necessary to appreciate the impact of the decision in K2 Investment, we offer a brief overview.
The K2 Investment case involved a legal malpractice claim brought against a New York attorney. K2 Investment Group, LLC loaned US$2.8 million to Goldan LLC, which the New York attorney partly owned. Goldan later became insolvent and failed to repay the loan, and K2 Investment’s mortgages on the property held by Goldan were not recorded and secured – leaving K2 Investment’s loan uncollectible.
K2 Investment claimed that the New York attorney also represented K2 Investment itself in the transactions and was therefore responsible. The New York attorney’s malpractice insurer, Zurich, concluded that he had not acted as counsel to K2 Investment and so had not committed malpractice. Zurich, however, owed the attorney a defense.
K2 obtained a default judgment against the attorney and later sued Zurich directly. Zurich admitted it had breached its duty to defend, but claimed that it owed no indemnity because of exclusions for legal malpractice claims arising out of the attorney’s status as an owner, director or officer of a business enterprise. K2 Investment disagreed, and on June 11, 2013 the Court of Appeals held that “when a liability insurer has breached its duty to defend its insured, the insurer may not later rely on policy exclusions to escape its duty to indemnify the insured for a judgment against him.”
In sum, New York law remains the same as it ever was. Insurers may rest easy that New York, after a brief step toward a very pro-policyholder approach, is back to its historic roots. Insurance policies are contracts that are to be applied as written. The breach of a duty to defend would entitle the insured to recoup reasonable defense expense, but no more and certainly it has no impact on whether or not there is indemnity. The insured must establish its right to indemnity based on the "actual facts" as Servidone held and as has always been the law of New York.