The New York Court of Appeals, the state’s highest court, recently held that an insurer that breached its duty to defend could not later rely on otherwise applicable exclusions to deny coverage for indemnification. Under this apparently new rule, an insurer’s wrongful failure to defend may result in the insurer’s liability for an amount up to its policy limits, even if a policy exclusion would otherwise preclude coverage for indemnification. This unanimous ruling potentially expands the indemnity obligation beyond the coverage afforded by the policy, although the court specifically affirmed the dismissal of the bad faith claims. As the Court suggests, the filing of a pre-denial declaratory judgment action may now be an important strategic consideration. It remains to be seen how broadly New York courts will apply this new rule, which the Court announced without express consideration of longstanding precedent.
Coincidentally, on June 11, 2013, the same day the Court of Appeals issued its decision in K2 Investment Group, the United States Court of Appeals for the Second Circuit issued its decision in CGS Industries, Inc. v. Charter Oak Fire Insurance Co. (June 11, 2013, Lynch, G.). In CGS Industries, the Second Circuit followed New York law as it was pre-K2 Investment Group law, finding that, although an insurer breached the policy contract by failing to provide a defense to its insured, it did not owe the insured indemnification. The CGS Industries opinion did not address the issue of bad faith.