NY Insurer Who Wrongfully Denied Defense May Rely on Policy Exclusions to Avoid Paying Indemnity

In 2013 New York?s highest court held that an insurance company could not rely on policy exclusions as a defense to pay indemnity after wrongfully denying a defense on the same claim. Now, less than a year later, the court decided to reconsider this punitive decision and has reversed its ruling. The court?s change of heart is certainly good news for the New York area?s insurance industry.

The case, K2 Investment Group, LLC v. American Guarantee & Liability Insurance Company, involved a claim for legal malpractice brought by an attorney, Jeffrey Daniels, against his insurance company American Guarantee. American Guarantee wrongfully denied Mr. Daniels a defense in a lawsuit brought by a former client. American Guarantee eventually conceded that it wrongly denied a defense to Mr. Daniels. Ultimately, the former clients were able to obtain a default judgment and Mr. Daniels assigned his right to sue American Guarantee to the former clients. The New York high court initially found that American Guarantee should be barred from relying on policy exclusions to avoid paying the default judgment, as a consequence of breaching its duty to defend.

Following that decision, American Guarantee asked to reargue the case before the high court because its decision was in direct conflict with the precedential case, Servidone Const. Corp. v. Security Ins. Co. of Hartford. The court accepted re-argument and reversed the initial K2 Investment decision. ?The court noted that Servidone is still good law and that the case represents the majority rule for the country. The court explained that the insurer in K2 Investment was relying on policy exclusions that did not depend on the facts that formed the basis for the default judgment. Therefore, it would not be inconsistent to allow the insurer to rely on the policy exclusions to avoid paying indemnity. The court cautioned that when an insurance company disclaims or coverage may be arguable, it is well advised to seek a declaratory judgment concerning the duty to defend or indemnify. The court noted that it did not see any justification for overruling the 1985 Servidone decision, as it has not proven to cause significant injustice or hardship.

The court then sent the case back down to the trial court to determine whether the exclusions relied on by American Guarantee would defeat the default judgment. In particular, the claim in K2 Investment involved an allegation that Mr. Daniels represented the plaintiffs as clients in a lending transaction. Mr. Daniels was also a principal in the lending company. Apparently, Mr. Daniels failed to record a mortgage resulting in a claim of malpractice. American Guarantee disclaimed based on an exclusions for claims arising out of (a) an insured?s status as an officer, director, partner, trustee, shareholder, manager or employee of a business enterprise, and (b) any acts or omissions by an insured for any business enterprise in which an insured has a controlling interest. The court noted that there was an issue of fact as to whether Mr. Daniels was acting solely as an attorney, solely as a principal of the mortgage company, or both. This issue was separate and apart from whether he may have committed malpractice that caused injury to the plaintiff. Therefore, it was proper for the trial court to consider the exclusion when determining whether American Guarantee was liable for the default judgment.

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