In its recent decision in Cincinnati Ins. Co. v. Roy’s Plumbing, Inc., 2014 U.S. Dist. LEXIS 73464 (W.D.N.Y. May 29, 2014), the United States District Court for the Western District of New York considered the implications of New York’s fee shifting rule in the wake of the New York Court of Appeals’ 2014 decision to vacate its 2013 ruling in K2 Inv. Group v. Am. Guarantee & Liability Ins. Co., 971 N.Y.S.2d 229 (June 11, 2013).
As initially decided in July 2013, the K2 decision – issued by New York’s highest state court – stood for the proposition that when an insurer breaches its duty to defend, then it is estopped from relying on policy exclusions in order to avoid an indemnity obligation. The Court suggested in its decision that a proper remedy for an insurer unsure of its coverage obligations is to seek a judicial declaration. The Court subsequently vacated its decision in February 2014, and in doing so, reaffirmed the long-standing rule in New York that an insurer can still rely on policy defenses for indemnity purposes even if it breached a duty to defend.
The Roy’s Plumbing decision arose out of a general liability insurer’s decision to file an affirmative declaratory judgment action against its insured based on the initial K2 decision. Cincinnati denied coverage to Roy’s Plumbing under several policies and thereafter filed suit against Roy’s Plumbing and the underlying plaintiffs in the Western District of New York in October 2013. Roy’s Plumbing, in turn, filed a counterclaim against Cincinnati seeking a declaration that it was entitled to a defense and indemnification. After the New York Court of Appeals vacated its decision in K2, Cincinnati asked Roy’s Plumbing to allow the suit to be dismissed. When Roy’s Plumbing refused, Cincinnati moved the court to dismiss its affirmative complaint and let Roy’s Plumbing continue to prosecute its claim against Cincinnati, thereby effectively making Cincinnati the defendant and Roy’s Plumbing the plaintiff.
Roy’s Plumbing opposed Cincinnati’s motion on the ground that if allowed, and Roy’s Plumbing were converted to the plaintiff, then it would lose its right to seek reimbursement of its legal fees pursuant to Mighty Midgets, Inc. v. Centennial Ins. Co., 416 N.Y.S.2d 559 (1979). Under the Mighty Midgets rule, an insured placed in a defensive litigation posture by its insurer is allowed to collect its legal fees if it successfully defends the suit. New York courts have refused to extend this rule to situations in which the insured successfully prosecutes a declaratory judgment action against its carrier. Cincinnati argued in response to Roy’s Plumbing’s opposition that it only brought suit because of the rule established K2 by the initial Roy’s Plumbing ruling, and that its need to affirmatively prosecute a lawsuit was obviated once the K2 decision was vacated.
The court rejected Cincinnati’s argument, reasoning that:
The fact that there has been a change in the case law which Plaintiff believed initially mandated its prosecution of this action is of no moment. There is no argument supporting a conclusion that Roy’s Plumbing should bear the burden of any such change by losing the possibility of recovering legal fees. Nor can it simply be assumed from the counterclaim that this Defendant would have chosen to commence an independent action in the absence of Plaintiff’s lawsuit.
The court also observed that the second K2 decision still recommended a declaratory judgment action as “sound advice” for resolving coverage issues. Thus, the court denied Cincinnati’s motion to dismiss, thereby preserving Roy’s Plumbing’s opportunity to collect fees under Mighty Midgets in the event that coverage was found in its favor.