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June 2013

Insurer in Breach of Duty to Defend May Not Rely on Policy Exclusions to Avoid Indemnity Obligation

The New York Court of Appeals held that an insurer in breach of its duty to defend may not rely on policy exclusions in a subsequent dispute over its duty to indemnify. The June 11 ruling in K2 Investment Group, LLC v. American Guarantee & Liability Ins. Co. expands a previous decision holding an insurer in breach of its duty to defend may not rely on liability defenses that would have defeated the underlying claim against its insured.

K2 Investment Group, LLC sued insured Goldan, LLC in connection with loans made to Goldan. The loans were to be secured by mortgages, but the mortgages were never recorded. When Goldan failed to repay the loans, K2 sued Goldan and two of its principals. K2 alleged one of Goldan’s principals, Jeffrey Daniels, had acted as K2’s attorney for the loans, and that Daniels’ failure to record the mortgages was “a departure from good and accepted legal practice.”

Daniels notified his malpractice insurer, American Guarantee, which refused to defend on the basis that the allegations against Daniels were not based on rendering or failing to render legal services for others. K2 obtained a judgment against Daniels in excess of the policy limits, which was entered only as to the malpractice claims. Daniels assigned his rights against American Guarantee to K2, which sued American Guarantee for breach of contract and bad faith failure to settle the underlying lawsuit.

American Guarantee moved for summary judgment contending two policy exclusions precluded coverage. K2 filed a cross-motion. The trial court granted K2’s motion, finding that American Guarantee breached its duty to defend and was bound to indemnify Daniels up to the limits of the policy. The trial court dismissed the bad faith claims. 

The Appellate Division affirmed the judgment, finding that the policy exclusions were inapplicable to K2’s claim against Daniels. A dissenting opinion, however, found that issues of fact existed as to whether the exclusions applied, and on that basis American Guarantee appealed as of right to the Court of Appeals.

The Court of Appeals affirmed the judgment.  It did not reach the issue of whether the exclusions applied to K2’s claim against Daniels. The court decided instead that, by breaching its duty to defend, American Guarantee lost the right to rely on those exclusions as to indemnity. 

The court first found it was “quite clear” that American Guarantee breached its duty to defend. The court agreed American Guarantee had a right to be skeptical of K2’s claims against Daniels, as it would be “unusual, in a loan transaction, for lenders to retain a principal of the borrower to act as their lawyer, as [K2] here claimed they did.” The court explained, however, that the duty to defend requires an insurer to defend a claim “within the embrace of the policy” even if it is “groundless, false or baseless.”

Turning to the exclusions, the court cited its decision, Lang v. Hanover Ins. Co., 3 NY3d 350 (2004), in which it found that, in defending a duty to indemnify claim, an insurer in breach of its duty to defend may not assert grounds that would have defeated the underlying claim against the insured. While acknowledging that Lang did not involve an insurer’s attempt to rely on its own policy exclusions, the court explained that it would apply the general rule from Lang: that an insurer in breach of its duty to defend “may litigate only the validity of its disclaimer.” This would “give insurers an incentive to defend the cases they are bound by law to defend, and thus to give insureds the full benefit of their bargain.” The court acknowledged there might be a public policy exception to the general rule (for example, in cases involving an insured’s intentional conduct), but did not reach the issue because no such arguments were presented by American Guarantee. 

Click here for the opinion. 

This opinion is not final.  It may be modified following reargument or reconsideration.  These events would render the opinion unavailable for use as legal authority.  This opinion is uncorrected and may be revised prior to official publication.

This and other case bulletins, as well as other publications of Gordon & Rees LLP, may be found at www.gordonrees.com.

Insurance

Arthur Schwartz



Insurance

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