Insurers know their duty to defend under a policy, is broader than their duty to indemnify. They err on the side of providing a defense, in part, fearing a bad faith judgment and unfair claim settlement practices regulatory penalties. The New York Court of Appeals in K2 Investment Group, LLC et. al. v. American Guarantee & Liability Insurance Company, 213 N.Y. LEXIS 1461, June 11, 2013 just offered an additional reason. Failure to defend may require the insurer to indemnify, regardless of policy exclusions. The Court of Appeals reinforced the liberal duty to defend set forth in its 2006 decision in Automobile Insurance Company of Hartford v. Cook, 7 N.Y.3d 131. Liberal construction is required if the complaint pleads a claim that is reasonably possible to cover. It does not matter how groundless, baseless, or false the suit might be.
In K2 creditors had sued Goldan, LLC for defaulting on $2.83 million in loans. One of the principals in Goldan, Jeffrey Daniels, was a lawyer, and purportedly represented the plaintiff creditors in their transaction with Goldan. They alleged as one of their claims that Mr. Daniels committed legal malpractice by failing to record their mortgages. Mr. Daniels requested that the Defendant provide a defense under his E&O cover, but the Defendant disclaimed defense or indemnity obligation. A default judgment was taken against Mr. Daniels. He assigned his rights under his E&O policy to the plaintiffs who then sued under the policy for breach of contract, as well as for bad faith, demanding the $2 million policy limit and the default judgment in excess of the policy limit. The Supreme Court awarded summary judgment to the plaintiffs for the policy limit on the basis of breach of contract. A majority of the Appellate Division, First Department affirmed, finding that the “insured status” and “business enterprise” exclusions relied upon by the Defendant were inapplicable to the malpractice action upon which the default judgment was taken. The New York Court of Appeals did the same.
While public policy might benefit an insurer who refuses to defend, it is an unreliable perch. The better practice is to take the DJ. The larger implication is whether policies are essentially litigation expense covers in NY and need to be rated as such, regardless of loss costs. While this loss would fall within the insurer’s reinsurance retention, a larger judgment may have faced a denial by its reinsurers. It would not neatly fit within ECO or XPL, given that breach of contract and not bad faith was the basis for the default judgment. Claims departments handling NY claims might want to listen to Take the A Train and just substitute for the title Take the DJ just as a reminder when they review complaints.