• Breach of Duty to Defend Precludes Reliance on Policy Exclusions in Indemnity Context
  • June 14, 2013 | Authors: Charles A. Jones; Jesse K. Martin; Pamela L. Signorello
  • Law Firms: Troutman Sanders LLP - Washington Office ; Troutman Sanders LLP - New York Office
  • On June 11, 2013, the New York Court of Appeals held that a liability insurer that breaches its duty to defend may not later rely on policy exclusions to escape its duty to indemnify. See K2 Investment Group, LLC, et al. v. American Guarantee & Liability Insurance Company, No. 106 (N.Y. June 11, 2013). A liability insurer that disclaims its duty to defend may litigate only the validity of its disclaimer, which, if found to have been improper, precludes reliance on policy exclusions that otherwise would have negated the duty to indemnify.

    Plaintiffs, the insured’s assignees of his rights under his legal malpractice policy, brought suit against American Guarantee and Liability Insurance Company for breach of contract and bad faith failure to settle the underlying legal malpractice action against the insured. The insurer previously had denied “either defense or indemnity coverage” for the lawsuit on the basis that the claims against its insured “are not based on the rendering or failing to render legal services for others.” Following American Guarantee’s ultimate rejection of a $450,000 settlement demand made on the insured, the insured defaulted in the underlying lawsuit, and a default judgment in excess of the policy’s $2 million limit was entered against him.

    In the coverage litigation that followed, plaintiffs sought to recover from American Guarantee the policy’s full $2 million limit on the contract claim and the full amount of the default judgment on the bad faith claim. American Guarantee moved for summary judgment, relying on two policy exclusions: the so-called “insured’s status” and “business enterprise” exclusions. Plaintiffs cross-moved for summary judgment. The New York Supreme Court granted plaintiffs’ cross-motion as to the breach of contract claim, holding that American Guarantee breached its duty to defend its insured. The court dismissed the bad faith claim. The Appellate Division affirmed.

    This week, the New York Court of Appeals affirmed the summary judgment in plaintiffs’ favor on the breach of contract claim. Notably, the court did so without reaching the question of the applicability of the policy’s exclusions. Rather, the court held, “by breaching its duty to defend [the insured], American Guarantee lost its right to rely on these exclusions in litigation over its indemnity obligation.” Having first concluded that the underlying lawsuit “unmistakably” pleads a claim for legal malpractice - thus establishing a duty to defend - the court then relied on Lang v. Hanover Ins. Co., 3 NY3d 350 (2004), for the proposition that “an insurance company that has disclaimed its duty to defend may litigate only the validity of its disclaimer.” (Indeed, the court in Lang had concluded that “an insurance company that disclaims in a situation where coverage may be arguable is well advised to seek a declaratory judgment concerning the duty to defend or indemnify the purported insured.”) According to this week’s decision, “[i]f the disclaimer is found bad, the insurance company must indemnify its insured for the resulting judgment, even if policy exclusions would otherwise have negated the duty to indemnify.” The court reasoned that it would be unfair to insureds, and would promote unnecessary and wasteful litigation, if an insurer that wrongfully has abandoned its insured’s defense could then require the insured to litigate the effect of policy exclusions on the duty to indemnify.