Insured Not Entitled To Recover Attorneys’ Fees in Coverage Action

On September 30, 2016, the Fourth Department issued a decision in Zelasko Constr., Inc. v. Merchants Mutual Insurance Co., 2016 NY Slip Op. 06328, reversing the motion court’s award of attorney’s fees to the insured in a coverage action, explaining:

The court erred in granting that part of the motion seeking attorneys' fees. This case is governed by the general rule that attorneys' fees and other litigation expenses are "incidents of litigation" that the prevailing party may not collect from the loser unless an award is authorized by agreement between the parties or by statute or court rule. Indeed, it is well established that an insured may not recover the expenses incurred in bringing an affirmative action against an insurer to settle its rights under the policy. Here, there is nothing in the insurance policy that obligates defendant to reimburse or indemnify plaintiff for attorneys' fees incurred by it in prosecuting an action to enforce the property coverage provisions of the policy, nor does plaintiff refer to any statute or a court rule authorizing its recovery of attorneys' fees from defendant.

(Citations omitted).

We have previously blogged about the right of an insured to recover its legal fees from the insurance carrier in a coverage action. In general, as the Fourth Department noted in Zelasko, a policyholder’s coverage claims are subject to the standard American Rule, under which each side bears its own legal fees. The New York Court of Appeals has recognized a limited exception to the rule, allowing fee-shifting in favor of the insured only when the insurance company commences a declaratory judgment action, thus, “cast[ing]” the insured “in a defensive posture.” See Mighty Midgets v. Centennial Ins. Co., 47 N.Y.2d 12, 21 (1979). Courts have questioned the wisdom of a rule treating declaratory judgment actions commenced by the insured differently from those commenced by the insurance company for fee-shifting purposes. Justice Kornreich of the New York County Commercial Division went so far as to encourage a litigant to appeal a decision denying attorneys’ fees based on the Mighty Midgets rule. See also Cowan v. Ernest, 2001 WL 30501, at *3 (S.D.N.Y. 2001) (“It seems anomalous for the entitlement to fees to turn on the fortuity of whether a party to an insurance contract is cast as the plaintiff or defendant.”). Nevertheless, the Mighty Midgets rule remains good law.

As we have noted in prior posts (see here and here), New York does not recognize a separate cause of action for bad faith claims handling. In a pair of 2008 decisions, the Court of Appeals permitted an insured to recover consequential damages on a claim for breach of the implied covenant of good faith and fair dealing. See Bi-Economy Market, Inc. v. Harleysville Ins. Co. of N.Y., 10 N.Y.3d 187 (2008) and Panasia Estates, Inc. v. Hudson Ins. Co., 10 N.Y.3d 200 (2008). It is not clear whether attorneys’ fees in a coverage action could constitute permissible consequential damages under these cases. The Fourth Department in Zelasko found that these precedents could not justify the attorneys’ fee award because there was no evidence in the record that the insurer did “not investigat[e] the claim in good faith, or that the insurer otherwise acted in bad faith.”

Finally, and relatedly, there is long-standing (if seldom applied) authority permitting recovery of attorneys' fees to a policyholder where the insurance company engages in "such bad faith in denying coverage that no reasonable carrier would, under the given facts, be expected to assert it." Sukup v. State of New York, 19 N.Y.2d 519, 522 (1967). This standard is hard to satisfy: If the insurer can demonstrate an "arguable basis" for disclaiming coverage, no fees are awarded, even if the insured prevails in the lawsuit. See, e.g., Greenberg Eleven Union Free School Dist. v. National Union Fire Ins. Co., 304 A.D.2d 334, 336-37 (1st Dep't 2003).