Posted: January 6, 2021

Insurer Not Entitled to Recoup Defense Costs Despite Finding of No Duty to Indemnify

Posted by Bradley J. Nash, Litigation Partner

On December 30, 2020, the Second Department issued a decision in American W. Home Ins. Co. v. Gjonaj Realty & Mgt. Co., 2020 NY Slip Op 08027, ruling that an insurer was not entitled to recoup defense costs it paid, despite the court’s determination that the insurer had no duty to indemnify.

Under New York law, a liability insurer’s duty to defend is “exceedingly broad” and is triggered whenever there is a “reasonable possibility” of coverage.  Thus, “an insurer may be contractually bound to defend even though it may not ultimately be bound to pay, either because its insured is not factually or legally liable or because the occurrence is later proven to be outside the policy’s coverage.”  In Gjonaj Realty, the insurer agreed to provide a defense subject to a reservation of rights, and later filed an action for a declaratory judgment that it had no duty to indemnify and to recoup the defense costs it paid.

The motion court ruled in favor of the insurer.  The Second Department affirmed the ruling that the insurer had no duty to indemnify but held that the insurer was not entitled to recoup defense costs, explaining:

In New York, although there are a handful of cases wherein courts—including federal courts interpreting New York law—have affirmed orders allowing an insurance company to recoup its defense costs upon a determination that no duty to indemnify exists, we decline to follow them. Indeed, none of the[se] [] cases address the issue of whether recouping defense costs is appropriate or authorized.  Moreover, in three of the cases cited by the insurance company, unlike this case, there is no indication that the request for defense costs was opposed by the insured on appeal.

Significantly, some of the federal courts—interpreting New York law—appear to be shifting course on this issue. Recently, in Crescent Beach Club LLC v Indian Harbor Ins. Co. (468 F Supp 3d at 554) and Century Sur. Co. v Vas & Sons Corp. (2018 WL 6164724, 2018 US Dist LEXIS 151209 [ED NY, No. 17-CV-5392 (DLI)]), the federal court for the Eastern District of New York found that an insurance company’s recoupment of defense costs was inappropriate where the policy at issue provided a duty to defend, but had no express contractual provision allowing for recoupment of defense costs.  We agree with this view.

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Here, the policy and the supplementary payment provision expressly promise the insureds that the insurance company will bear all the costs “to defend the insured against any ‘suit'” to which the policy covers while the policy is silent as to any reimbursement by the insurance company for the costs of defense incurred prior to a declaratory judgment determining that the insurer has no obligation to defend or indemnify the insured in the underlying action. . . .  Indeed, if the insurance company had wanted to include language that allowed it to recover the costs of defending claims that are later determined not covered, it could have done so. It did not. Since insurance policies are written contracts, when a policy such as the one at issue uses language obligating the insurer to defend any “suit” alleging a covered claim, and does not reserve a right to seek reimbursement from the insured, it obligates the insurance company at its own cost to defend the insureds until a judicial determination . . . that the underlying action was not covered by the policy.

To the extent that the insurance company argues that the policy does not cover the defense of an excluded claim, the policy also does not expressly provide that where a claim is excluded, the insurance company may seek and obtain reimbursement of the costs for defending the excluded claim.  There is little doubt that the insurance company could have included in the policy a provision wherein it could recover its defense costs (upon a reservation of rights and a judicial determination that it is not required to indemnify) had it wanted to, but it did not do so here.

(Some citations omitted).

The insurer purported to condition its agreement to defend the insured on its right to recoup defense costs if it was ultimately determined that there was no duty to indemnify.  The Second Department found that this did not establish a right to recoup, since “a unilateral reservation of rights letter cannot create rights not contained in the insurance policy.”

Notably, under New York law, insurers are sometimes required to advance defense costs to the insured even where the policy does not impose a duty to defend.  In that context, because the payment of defense costs is an advance on the insurer’s duty to indemnify, the insurer may be able to recoup the advanced funds if it is determined that there is no indemnity coverage.  The Second Department’s decision preserves the important distinction between the duty to advance and the independent duty to defend.

Posted in Duty to Defend
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