Rare New York Court of Appeals Reversal in Significant Insurance Coverage Decision

March 7, 2014

It is extremely rare that the New York Court of Appeals grants a motion to reargue, and even rarer that it reverses its decision upon such a motion. But that is exactly what happened recently, and the court's latest decision represents a significant victory for liability insurers in situations following a finding that an insurer has breached its duty to defend its insured.

In June 2013, in K2 Investment Group, LLC v. American Guaranty & Liability Insurance Co., [21 N.Y.3d 384 (N.Y. 2013)] (K2-I), the New York Court of Appeals ruled that if a liability insurer breached its duty to defend, it was subsequently precluded from relying on policy exclusions to deny a duty to indemnify its insured with respect to an underlying judgment or settlement. Based on K2-I, an insurer's improper refusal to defend its insured meant that it may be liable up to its policy limits — even if the policy contained an exclusion that would have precluded a duty to indemnify.

The K2-I decision was directly contrary to well-established New York precedent — sometimes referred to as the "Servidone" rule (Servidone Const. Corp. v. Security Ins. Co. of Hartford, [64 N.Y. 2d 419 (1985)] — namely, that where an insurer had improperly refused to defend its insured, the insurer was precluded from re-litigating the amount of damages, but was still entitled to assert that coverage did not apply based on policy exclusions.

On February 18, 2014, the New York Court of Appeals, in a 4-2 split decision, vacated its K2-I opinion, and issued its opinion in K2-II, which essentially restated and reaffirmed the Servidone rule that an insurer will not lose its right to litigate coverage defenses following a finding that it had breached its duty to defend. In K2-II, the court held that where an insurer has breached its duty to defend, the insurer is not automatically liable to indemnify its insured for the underlying judgment/settlement, but rather can still litigate coverage issues and rely on policy exclusions to defeat its duty to indemnify.

The K2-II ruling is certainly good news for insurers, and is consistent with a majority of states on this issue, holding that coverage cannot be created by estoppel, and that the duties of an insurer to defend and indemnify are separate and distinct.

For more information on this and other insurance matters, please contact:

Alan R. Lyons at at +1 212 592 1539 or [email protected]