New York’s Highest Court Rappels Down From Possible Major Shift in Insurance Law in K2 Decision

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Today, the New York Court of Appeals elected to adhere to precedent in holding that an insurer is indeed allowed to rely on its policy exclusions when faced with a request for indemnity, even if the insurer was not correct in deciding that it did not have a duty to defend. K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co., — N.Y.3d –, 2014 WL 590662 (N.Y. Feb. 18, 2014) (“K2-II”). The K2-II decision follows reargument of an earlier decision by the Court of Appeals issued on June 13, 2013. 21 N.Y.3d 384, 971 N.Y.S.2d 229 (N.Y. June 11, 2013) (“K2-I”).

As background, legal malpractice claims had been brought against American Guarantee & Liability Insurance Company’s insured, Jeffrey Daniels. American Guarantee determined that its legal malpractice policy did not cover the claim and, therefore, it did not owe a defense to Daniels, although the court decided otherwise. K2-II at 2. In the underlying malpractice action, the court entered a default judgment against Daniels. Daniels then assigned his rights under the American Guarantee policy to plaintiffs. Plaintiffs, in turn, brought suit against American Guarantee seeking coverage for the judgment entered against Daniels. American Guarantee maintained it had no obligation to provide indemnification for the judgment because “the loss sought was not covered[.]” K2-II at 2. The trial court disagreed with American Guarantee’s position, and granted plaintiffs’ motion for summary judgment. This determination was affirmed on two appeals, the latest under K2-I, on the basis that “American Guarantee’s breach of its duty to defend barred it from relying on policy exclusions.” K2-II at 2.

American Guarantee requested a re-hearing of the K2-I decision, which the Court of Appeals granted on September 3, 2013. Upon rehearing, the court agreed with American Guarantee, noting that the court had failed to “take account of a controlling precedent, Servidone Const. Corp. v. Security Ins. Co. of Hartford (64 NY2d 419 [1985]).” K2-II at 1-2. As a result, the Court of Appeals vacated its decision in K2-I, and reversed the Appellate Division’s order.

The Court of Appeals’ decision in K2-II is largely tied to Servidone. At issue in Servidone was whether an insurer that had breached its duty to defend would be barred from raising coverage defenses to a request for indemnification of a subsequent, reasonable settlement. There, the answer was no; the insurer would not be barred from raising potentially applicable coverage defenses. See K2-II at 2-3. In K2-I, the Court of Appeals had 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.” K2-II at 3 (citations omitted). In reaching today’s decision, the Court of Appeals stated that, “[t]he Servidone and K2-I holdings cannot be reconciled.” K2-II at 3. The Court of Appeals also: (1) rejected plaintiffs’ attempt to distinguish Servidone because it involved a settlement, rather than a judgment as was the case in K2; (2) stated that Lang v. Hanover Ins. Co., in which the Court of Appeals held that, “when an insurer has refused to defend its insured, it may litigate only the validity of the disclaimer,” did not apply because “the issue we now face was not presented in Lang,” i.e., “we did not consider any defense based on policy exclusions;” (3) pointed to various other jurisdictions that follow the Servidone approach; and (4) invoked the rule of stare decisis, stating that it is “strong enough” to govern this case. K2-II at 3-6 (citations omitted).

The K2-II decision will come as a relief to insurers, as the Court of Appeals potentially was going to blaze a new path for New York insurance law and significantly restrict an insurer’s ability to deny coverage under an applicable policy exclusion. The court aptly noted: “When our Court decides a question of insurance law, insurers and insureds alike should ordinarily be entitled to assume that the decision will remain unchanged unless or until the Legislature decides otherwise.” K2-II, at 6. However, insurers should be mindful that the rule still exists in New York that, if it does not provide a defense to its insured, it may not relitigate the issues in the underlying action.